Kraft Heinz Co quarterly report, Q2 FY2018

Kraft Heinz Co. Form 10-Q Summary

Business context and reporting period

The filing covers the unaudited three and six months ended June 30, 2018, compared with July 1, 2017. Kraft Heinz manufactures and markets food and beverage products globally across the United States, Canada, EMEA, and Rest of World. The company reorganized its international segment structure in 2018 and acquired Cerebos Pacific Limited on March 9, 2018.

Financial performance and key metrics

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net sales	$6.686 billion	$6.637 billion	$12.990 billion	$12.961 billion
Operating income	$1.329 billion	$1.644 billion	$2.810 billion	$3.077 billion
Net income attributable to common shareholders	$756 million	$1.159 billion	$1.749 billion	$2.052 billion
Diluted EPS	$0.62	$0.94	$1.43	$1.67
Adjusted EBITDA	$1.974 billion	$2.065 billion	$3.769 billion	$3.909 billion
Adjusted EPS	$1.00	$0.98	$1.89	$1.82
Operating cash flow	Not separately presented for the quarter	$229 million	$(178) million

Q2 gross profit was $2.365 billion, producing a gross margin of approximately 35.4%, versus approximately 36.7% in the prior-year quarter. Operating margin was approximately 19.9%, versus 24.8%. Net margin attributable to common shareholders was approximately 11.3%, versus 17.5%. For the six months, gross margin was approximately 35.5%, operating margin approximately 21.6%, and net margin attributable to common shareholders approximately 13.5%.

Q2 net sales increased 0.7%, but organic net sales declined 0.4%; pricing contributed 1.3 percentage points while volume/mix reduced sales by 1.7 points.
Six-month net sales increased 0.2%, while organic net sales declined 0.9%; pricing contributed 1.1 points and volume/mix reduced sales by 2.0 points.
Q2 operating income declined 19.1% and six-month operating income declined 8.7%. Q2 net income attributable to common shareholders declined 34.8%, and six-month net income declined 14.8%.
Adjusted EBITDA declined 4.4% in Q2 and 3.6% for the six months, primarily because of higher input costs, unfavorable volume/mix, and strategic investments.
Cash, cash equivalents, and restricted cash totaled $3.375 billion at June 30, 2018, including $3.369 billion of cash and cash equivalents. Approximately $1.2 billion of cash and cash equivalents was held by international subsidiaries.
Long-term debt, including the current portion, was approximately $34.1 billion at June 30, 2018, compared with $31.1 billion at December 30, 2017. Total debt carrying value was approximately $34.2 billion and fair value was $33.8 billion.
The company had no commercial paper outstanding at June 30, 2018 and no borrowings under its $4.0 billion senior unsecured revolving credit facility. The facility maturity was extended to July 6, 2023, and a $400 million euro-equivalent swing line was added.
Capital expenditures were $438 million for the six months, and management expected full-year 2018 capital expenditures of approximately $850 million.
Common dividends paid during the six months totaled $1.659 billion. The board subsequently declared a $0.625 per-share dividend payable September 14, 2018.

Material changes versus the prior comparable period

Results were affected by $265 million of non-cash impairment losses in 2018, compared with $48 million in Q2 2017. The 2018 charges included $164 million related to an Australia and New Zealand reporting unit and $101 million related to the Quero brand in Brazil.
Integration and restructuring expenses were $157 million in Q2 and $247 million for the six months, compared with a net gain of $6 million in Q2 2017 and expenses of $142 million for the six months of 2017. The company expects approximately $10 million of additional Integration Program costs, primarily in Q3 2018.
Other expense/income was $35 million of income in Q2 2018 versus $253 million of income in Q2 2017. The prior period benefited from a $168 million postretirement-plan curtailment gain, while the current period included a $58 million pension settlement charge.
Interest expense increased to $318 million in Q2 and $635 million for the six months, primarily following the June 2018 issuance of $3.0 billion of senior notes.
The six-month effective tax rate declined to 24.0% from 27.8%, primarily reflecting U.S. Tax Reform. The Q2 rate increased to 27.9% from 27.1% because of discrete tax items, including deferred-tax revaluation and the non-deductible goodwill impairment.
Operating cash flow improved from a use of $178 million in the prior-year six months to $229 million provided in 2018, helped by a federal tax refund and lower bonus payments, but working capital remained a significant use of cash.
The company acquired Cerebos for approximately $238 million, including $19 million of preliminary goodwill, and sold its 50.1% interest in a South African subsidiary for $18 million of proceeds, recording a $15 million pre-tax loss.
The U.S. accounts receivable securitization program was unwound in Q2. Trade receivables removed from the balance sheet under the remaining programs declined to $199 million from $1.0 billion at year-end 2017.

Segment trends, outlook, and risks

United States sales declined 1.9% in Q2 and 2.6% for the six months; Segment Adjusted EBITDA declined 8.0% and 6.9%, respectively, reflecting lower volume/mix, commodity inflation, and strategic investments.
Canada organic sales declined 8.2% in Q2 and 2.5% for the six months, primarily because of unfavorable volume/mix. Segment Adjusted EBITDA declined 8.9% and 2.5%, respectively.
EMEA organic sales increased 4.0% in Q2 and 3.8% for the six months, with Segment Adjusted EBITDA increasing 8.9% and 18.2%, respectively. Currency, productivity, and volume/mix supported results.
Rest of World organic sales increased 10.8% in Q2 and 7.0% for the six months, while Segment Adjusted EBITDA increased 24.6% and 13.1%. Pricing and acquisitions supported sales, but Venezuelan currency devaluation and higher local input costs were headwinds.
Management stated that operating cash flow, commercial paper programs, and the revolving credit facility should provide sufficient liquidity for working capital, restructuring, capital expenditures, debt maturities, pension obligations, and dividends.
Management expected approximately $850 million of 2018 capital expenditures, approximately $30 million of additional Integration Program capital expenditures, approximately $10 million of additional Integration Program costs, and approximately $20 million of additional 2018 pension and postretirement contributions.
Key risks include weak volume and mix, commodity and energy cost inflation, competitive and retail-channel pressures, foreign exchange volatility, Venezuela’s highly inflationary environment, substantial goodwill and brand-related impairment exposure, indebtedness and refinancing needs, pension obligations, tax-law changes, legal and regulatory matters, product liability, cybersecurity, and the ability to realize cost savings.
Four reporting units had less than 10% excess fair value over carrying value, and two brands also had less than 10% excess fair value, creating sensitivity to future operating deterioration or changes in valuation assumptions.
The filing states that pending legal matters are not expected to have a material adverse effect, and that there were no material changes to the risk factors disclosed in the 2017 Form 10-K.

Important facts for investors to verify

Whether pricing actions can offset persistent volume/mix declines, input-cost inflation, and strategic investment spending, particularly in the United States and Canada.
The performance of the impaired Australia and New Zealand reporting unit, the Quero brand, and the other reporting units and brands with limited valuation headroom.
Debt maturities in July and August 2018, post-issuance leverage, interest costs, and the company’s ability to maintain dividend payments while reducing debt.
The sustainability of operating cash flow after the U.S. securitization wind-down and the effect of receivables, inventories, and other working-capital movements.
The final purchase-price allocation and integration performance for Cerebos.
Future effects of U.S. Tax Reform, GILTI, deferred-tax remeasurement, and the completion of provisional tax accounting.
Developments in Venezuela, including currency access, devaluation, government controls, and the risk of future impairment or deconsolidation.
The filing is unaudited, and interim results are not necessarily indicative of full-year performance.