Kraft Heinz Co. Form 10-Q Summary
Business context and reporting period
Filed August 10, 2015, for the quarter and six months ended June 28, 2015. The statements reflect legacy H.J. Heinz Holding Corporation only; Kraft Foods Group results are excluded because the merger closed on July 2, 2015. Kraft Heinz began reporting Kraft operations in the quarter ended September 27, 2015.
The company operates in North America, Europe, Asia/Pacific, Latin America, and RIMEA, with core categories including ketchup and sauces, meals and snacks, and infant/nutrition. Approximately 70% of sales were outside the United States.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Sales | $2.616 billion | $2.729 billion | $5.094 billion | $5.529 billion |
| Gross profit | $951 million | $885 million | $1.928 billion | $1.839 billion |
| Gross margin | 36.4% | 32.4% | 37.9% | 33.2% |
| Operating income | $444 million | $374 million | $953 million | $807 million |
| Net income attributable to Kraft Heinz | $(164) million | $127 million | $112 million | $322 million |
| Net loss attributable to common shareholders | $(344) million | $(53) million | $(248) million | $(38) million |
| Diluted loss per common share | $(0.91) | $(0.14) | $(0.66) | $(0.10) |
| Adjusted EBITDA | $739 million | $693 million | $1.390 billion | $1.382 billion |
Quarterly sales declined 4.1%, while six-month sales declined 7.9%. Adjusted EBITDA increased 6.7% in the quarter and 0.6% for the six-month period. SG&A declined 7.4% in the quarter and 9.5% year to date.
At June 28, 2015, cash and cash equivalents were $2.147 billion versus $2.298 billion at December 28, 2014. Total debt was approximately $13.6 billion, including $13.626 billion of long-term debt. The company had $4.589 billion of current assets and $2.653 billion of current liabilities. Approximately $1.8 billion of cash and short-term investments was held by international subsidiaries.
Operating cash flow was $411 million for the first six months, compared with $847 million in the prior-year period. Investing activities provided $150 million, including $306 million of net investment hedge proceeds, while financing activities used $379 million. Capital expenditures were $163 million. Preferred dividends paid were $360 million.
Material changes versus the prior comparable period
- Foreign exchange translation reduced second-quarter sales by 9.4% and six-month sales by 8.2%.
- Net pricing increased second-quarter sales by 4.2% and six-month sales by 4.5%; volume increased 1.7% in the quarter but decreased 3.9% year to date.
- Gross margin improved substantially because of lower restructuring charges, benefits from prior productivity initiatives, and lower product costs, partly offset by foreign exchange, trademark impairments, and Venezuela-related charges.
- Interest expense increased by $222 million in the quarter and $250 million year to date, primarily because $227 million of deferred losses from terminated interest-rate swaps were reclassified from accumulated other comprehensive income to interest expense.
- Other expense increased to $255 million in the quarter and $226 million year to date, principally because of a $234 million Venezuela foreign-exchange devaluation loss.
- Quarterly sales increased in North America and Latin America but declined in Europe, Asia/Pacific, and RIMEA. Europe and Asia/Pacific were particularly affected by currency translation, while Latin America benefited from Venezuela pricing and volume effects.
Merger, outlook, unusual items, and risks
The Kraft merger closed July 2, 2015. Total consideration was preliminarily estimated at $52.9 billion, including a $9.8 billion special cash dividend to Kraft shareholders. The preliminary allocation included $32.9 billion of goodwill and $43.652 billion of identifiable intangible assets. A $348 million inventory fair-value step-up was expected to be recognized in cost of products sold after closing. Pro forma sales were $7.129 billion for Q2 2015 and $13.957 billion for the first six months, but these figures are not reported GAAP results and exclude anticipated integration savings.
On July 2, 2015, the company issued $12.9 billion of investment-grade debt to refinance Heinz debt, repay Kraft revolving borrowings, and fund related fees and general corporate purposes. It also redeemed $0.8 billion of the 4.875% second-lien notes.
Management stated that operating cash flow, cash balances, credit facilities, and capital-market access were expected to be adequate for operations, capital spending, debt maturities, and interest payments. No formal revenue or earnings guidance was provided in the filing. The company expected a multi-year integration program with material exit, disposal, severance, and post-retirement costs, but could not estimate the total amount or duration.
- Venezuela was treated as highly inflationary. The company changed its remeasurement rate to the SIMADI rate of BsF 197.7 per U.S. dollar, producing a $234 million devaluation loss and a $49 million inventory write-down. The company also reported $23 million of unpaid requests for ingredient and packaging invoices.
- The company recorded a $58 million impairment charge on indefinite-lived trademarks. Goodwill was not impaired, but the North America Consumer Products reporting unit had less than 10% fair-value cushion and approximately $7.9 billion of goodwill.
- Restructuring and productivity charges were $35 million in Q2 and $52 million for the six-month period, versus $117 million and $257 million, respectively, in the comparable periods.
- The $8.0 billion Series A preferred stock carries a 9% annual dividend, approximately $720 million annually, and was presented outside shareholders’ equity because it is contingently redeemable.
- Key risks include merger integration, substantial leverage, foreign exchange and hyperinflation, commodity and energy costs, brand and consumer preference changes, retailer concentration, product liability and recalls, goodwill and trademark impairment, information technology disruptions, and access to capital markets.
Most important facts for investors to verify
- Review post-merger filings to assess the actual contribution of Kraft Foods Group, purchase accounting adjustments, integration costs, and realized synergies.
- Reconcile reported GAAP earnings with Adjusted EBITDA and evaluate the recurring nature of excluded items, especially Venezuela charges, merger costs, impairments, and restructuring.
- Monitor debt refinancing, interest expense, covenant compliance, maturities, and the effect of the July 2015 $12.9 billion debt issuance.
- Assess liquidity after preferred dividends, capital expenditures, working-capital requirements, and restricted or overseas cash considerations.
- Track Venezuela’s exchange rates, access to foreign currency, unpaid supplier invoices, operating results, and potential additional write-downs.
- Evaluate the sensitivity of goodwill and trademark valuations to weaker growth, higher discount rates, currency movements, and continued category declines.
- Confirm the size and timing of future integration and restructuring charges, which management had not yet estimated reliably.