Kraft Heinz Company — Q3 2019 Form 10-Q Summary
Business context and reporting period
The filing covers the three and nine months ended September 28, 2019, compared with the restated periods ended September 29, 2018. Kraft Heinz manufactures and markets food and beverage products globally through its United States, Canada, EMEA, and Rest of World segments. Management expects organizational changes to potentially result in revised reportable segments beginning in the first quarter of 2020.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $6,076 million | $6,383 million | $18,441 million | $19,377 million |
| Organic net sales | $6,116 million | $6,185 million | $18,409 million | $18,693 million |
| Operating income | $1,180 million | $1,074 million | $2,476 million | $3,931 million |
| Net income attributable to common shareholders | $899 million | $619 million | $1,753 million | $2,376 million |
| Diluted EPS | $0.74 | $0.50 | $1.43 | $1.94 |
| Adjusted EBITDA | $1,469 million | $1,594 million | $4,500 million | $5,350 million |
| Operating cash flow | Not separately provided | Not separately provided | $1,990 million | $878 million |
- Q3 net sales declined 4.8%; organic net sales declined 1.1%, reflecting unfavorable volume/mix of 2.1 percentage points, partly offset by 1.0 percentage point of higher pricing.
- For the nine months, net sales declined 4.8% and organic net sales declined 1.5%, driven by unfavorable volume/mix and lower pricing.
- Q3 gross margin was approximately 32.0%, versus 32.8% in the prior-year quarter. Nine-month gross margin was approximately 32.8%, versus 34.6%.
- Q3 operating margin was approximately 19.4%, versus 16.8%, benefiting from substantially lower impairment losses. Nine-month operating margin declined to approximately 13.4% from 20.3% because of higher impairment charges.
- Q3 adjusted EBITDA declined 7.8% and nine-month adjusted EBITDA declined 15.9%, reflecting lower organic sales, foreign exchange, higher supply-chain costs, higher corporate expenses, and strategic investments.
- Goodwill and intangible-asset impairment losses totaled $1,223 million in the first nine months of 2019, compared with $451 million in the restated prior-year period. The 2019 charges included $744 million of goodwill impairments and $479 million of intangible-asset impairments.
- Cash and cash equivalents were $2,315 million at September 28, 2019, compared with $1,130 million at December 29, 2018. Approximately $1.5 billion was held by international subsidiaries.
- Long-term debt, including the current portion, was approximately $30.7 billion at September 28, 2019, compared with $31.1 billion at year-end 2018. No commercial paper was outstanding, and no amounts were drawn under the $4.0 billion revolving credit facility.
- Capital expenditures were $581 million through nine months; management expected approximately $750 million for full-year 2019.
Material changes versus the prior comparable period
- Reported Q3 net income and EPS increased primarily because the prior-year quarter included $217 million of intangible impairment losses, while the current quarter included only $5 million. The current quarter also benefited from a $241 million gain on the Canada Natural Cheese divestiture and lower Venezuelan currency-devaluation losses.
- Nine-month net income and EPS declined despite divestiture gains because 2019 included $1.223 billion of impairment losses, versus $451 million in 2018, and higher interest expense.
- Kraft Heinz completed the Heinz India divestiture for approximately $655 million, recognizing a $249 million pre-tax gain, and completed the Canada Natural Cheese transaction for approximately $1.236 billion, recognizing a $241 million pre-tax gain.
- The company acquired Primal Nutrition for $201 million in January 2019, including $124 million of goodwill.
- The company issued $3.0 billion of long-term notes in September 2019 and used the proceeds, together with cash, to fund debt tender offers and related transactions. It recognized an $88 million loss on debt extinguishment.
- Dividends paid during the first nine months were $1.464 billion, and the board declared an additional $0.40 per-share dividend payable December 13, 2019.
Guidance, outlook, commentary, risks, and unusual items
- No full-year revenue or earnings guidance is provided in the filing. The stated 2019 capital-expenditure expectation was approximately $750 million.
- Management cited continuing pressure from weak volume/mix, supply-chain and input-cost inflation, foreign-exchange movements, strategic investments, retailer negotiations, and weakness in certain international categories.
- Goodwill and brand valuations remain a significant risk. Goodwill totaled $35.8 billion and indefinite-lived intangible assets totaled $43.4 billion at September 28, 2019. Management identified reporting units and brands with limited excess fair value and heightened risk of additional impairment if discount rates, growth, margins, market capitalization, or forecasts deteriorate.
- The company continued to report material weaknesses in internal control over financial reporting relating to risk assessment, supplier contracts and related arrangements, and goodwill and indefinite-lived intangible-asset impairment testing. Disclosure controls were therefore deemed ineffective as of September 28, 2019. Management targeted completion of remediation actions by early 2020.
- The prior-period financial statements were restated following an SEC procurement-related subpoena and an internal investigation that identified employee misconduct and timing errors involving supplier rebates, incentives, pricing arrangements, embedded leases, income taxes, impairments, and other items.
- The SEC investigation continued, with additional subpoenas covering financial reporting, internal controls, impairment assessments, shareholder communications, and procurement matters. The filing states that the potential scope, duration, outcome, and financial impact cannot be predicted.
- The company faced securities class actions, ERISA litigation, and shareholder derivative actions related to alleged misleading disclosures, internal controls, impairment assessments, and fiduciary matters. Potential losses could not reasonably be estimated due to the early stage of proceedings.
- Venezuela remained subject to highly inflationary accounting, currency controls, import and pricing restrictions, and significant economic uncertainty. The company recorded $10 million of Venezuelan currency-devaluation losses in the first nine months.
Important facts for investors to verify
- Whether management completes remediation of the material weaknesses and whether the SEC or other authorities initiate enforcement actions.
- The sustainability of organic sales, volume/mix trends, adjusted EBITDA, and margins after excluding divestiture gains, impairment charges, restructuring, and other unusual items.
- Potential additional goodwill or brand impairments, particularly for reporting units and brands with 20% or less excess fair value.
- Debt maturities and liquidity following the September tender offers, the October 2019 redemptions, and remaining 2020 maturities.
- The cash-flow quality of the $1.990 billion operating cash flow, including working-capital effects and the absence of the prior-year receivables-securitization activity.
- The financial and operational effects of the Heinz India and Canada Natural Cheese divestitures, the Primal Nutrition acquisition, and expected segment-reporting changes.