Kraft Heinz Co quarterly report, Q3 FY2015

Kraft Heinz Co. — 2015 Q3 Form 10-Q Summary

Business context and reporting period

The filing covers the three and nine months ended September 27, 2015. Kraft Heinz manufactures and markets food and beverage products globally, including condiments, sauces, cheese, dairy, meals, meats, beverages, coffee, infant nutrition and snacks.

Heinz completed its merger with Kraft Foods Group on July 2, 2015. Accordingly, reported 2015 results include Kraft only from the merger date, making direct comparisons with 2014 highly limited. Kraft contributed $3.9 billion of net sales and a $90 million net loss from the merger date through September 27, 2015.

Key financial metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Net sales	$6.120 billion	$2.594 billion	$11.214 billion	$8.123 billion
Gross profit	$1.628 billion	$767 million	$3.357 billion	$2.382 billion
Gross margin	26.6%	29.6%	29.9%	29.3%
Operating income	$399 million	$409 million	$1.352 billion	$1.216 billion
Operating margin	6.5%	15.8%	12.1%	15.0%
Net income attributable to Kraft Heinz	$(123) million	$172 million	$(11) million	$494 million
Net loss attributable to common shareholders	$(303) million	$(8) million	$(551) million	$(46) million
Diluted loss per share	$(0.27)	$(0.02)	$(0.87)	$(0.12)

Reported sales increased 135.9% in the quarter and 38.1% year to date, primarily because of the merger. On a pro forma basis, assuming the combined company existed in the prior periods, sales declined 9.0% in the quarter and 6.0% year to date. Pro forma organic sales declined 2.0% and 1.0%, respectively, as unfavorable volume and mix more than offset pricing.

Adjusted pro forma EBITDA was $1.482 billion in Q3 and $4.864 billion for the nine months, down 3.4% and up 0.6%, respectively. Adjusted pro forma EPS was $0.44 in Q3 and $1.57 year to date, compared with $0.46 and $1.43, respectively.

Cash flow, debt and liquidity

Operating cash flow was $746 million for the nine months, down from $1.331 billion in the comparable period, reflecting lower working-capital benefits, cash taxes and merger costs.
Capital expenditures were $366 million, compared with $247 million in the prior-year period.
Investing cash outflow was $9.401 billion, including $9.468 billion paid to acquire Kraft, partially offset by $481 million of net investment hedge proceeds.
Financing cash inflow was $11.191 billion, including $10.0 billion of sponsor equity and $14.823 billion of long-term debt issuance, offset by $12.308 billion of debt repayments and $1.177 billion of preferred and common dividends.
Cash and cash equivalents were $4.437 billion at September 27, 2015, compared with $2.298 billion at December 28, 2014.
Long-term debt increased to $25.250 billion from $13.358 billion at year-end 2014. Total debt, including current maturities and capital leases, was approximately $25.3 billion.
The company had a $4.0 billion revolving credit facility, with no borrowings outstanding, and a $600 million term loan outstanding. Management stated that it expected operating cash flow and available credit to meet working capital, integration, capital expenditure, benefit and dividend needs.
The 9.00% Series A cumulative redeemable preferred stock had a carrying value of $8.320 billion and generated $540 million of dividends during the nine months.

Material changes versus the prior comparable period

The Kraft merger substantially increased reported scale, assets and liabilities. Total assets rose to $121.792 billion from $36.535 billion, including $46.750 billion of goodwill and $56.693 billion of intangible assets.
Interest expense increased to $460 million in Q3 and $1.055 billion for the nine months, driven by assumed Kraft debt, refinancing activity, a $236 million debt issuance-cost write-off year to date and a $227 million charge from terminating interest-rate hedges.
Other expense increased to $108 million in Q3 and $314 million year to date, including $105 million of debt call premiums and a $234 million Venezuelan currency devaluation charge.
Integration and restructuring expenses were $482 million in Q3 and $587 million year to date, compared with $141 million and $445 million, respectively, in the prior periods.
The company changed the classification of certain warehouse and distribution costs, trademark and license impairment and amortization, and customer-related intangible amortization. Prior periods were retrospectively revised; these changes affect expense classification but not total operating income.
Common shareholders received a $637 million quarterly dividend in Q3. The board subsequently declared a $0.575 per-share dividend payable November 20, 2015, implying an annualized rate of $2.30 per share.

Guidance, outlook, management commentary and risks

The Integration Program is expected to produce $1.5 billion of pretax savings by 2017 and incur approximately $1.9 billion of pretax costs, with approximately 60% expected to be cash expenditures. The company also anticipates approximately $1.1 billion of related capital expenditures.
Planned actions include eliminating approximately 2,650 positions through organizational changes and approximately 2,600 positions through factory and distribution-network optimization. Management announced the closure of seven additional factories on November 4, 2015, after the quarter ended.
Management cited unfavorable currency, lower volume and mix, and international weakness as principal headwinds. Commodity costs remained volatile; dairy and meat costs declined while coffee and nut costs increased during the nine months.
Venezuela is accounted for as highly inflationary. The company used the SIMADI rate following a June 2015 reassessment, producing the $234 million devaluation charge. Outstanding requests for payment of ingredient and packaging invoices totaled $26 million at quarter-end.
Goodwill and indefinite-lived intangible assets are subject to impairment risk. The filing states that the fair values of certain reporting units and brands were less than 10% above carrying values, making them sensitive to lower growth or higher discount rates.
Unrecognized tax benefits were $357 million at quarter-end. The company had fully reserved an issue following an unfavorable foreign tax court decision and stated that unrecognized tax benefits could decrease by as much as $127 million over the next 12 months.
Management stated that pending legal matters, including the CFTC wheat-futures litigation inherited through Kraft, were not expected to have a material adverse effect, although outcomes remain uncertain.
Principal disclosed risks include integration execution, leverage and debt service, dividend obligations, brand and customer concentration, commodity and currency volatility, pension and postemployment obligations, impairment, tax matters, litigation, product liability, regulation and international economic conditions.

Important facts for investors to verify

Reconcile reported results with pro forma and non-GAAP measures because 2015 reported results include Kraft only after July 2, 2015.
Assess whether the projected $1.5 billion of integration savings can offset the $1.9 billion of expected costs and approximately $1.1 billion of related capital spending.
Monitor leverage, refinancing requirements, interest expense and the company’s ability to fund the 9.00% preferred dividend and common dividends.
Evaluate organic volume and mix trends, particularly in the United States and Canada, where pro forma sales declined.
Review sensitivity of the $46.750 billion goodwill balance and $56.693 billion intangible asset balance to operating performance, currency and discount-rate changes.
Track Venezuela’s currency regime, liquidity constraints and potential additional devaluation or impairment charges.
Confirm the final purchase price allocation for Kraft, which remained preliminary at the reporting date.
Review subsequent events, including the October 9, 2015 receivables securitization program and the November 4, 2015 factory-closure announcement.