Kraft Heinz Co annual report, FY2017

Kraft Heinz Company 2017 Form 10-K Summary

Business Context and Reporting Period

Kraft Heinz manufactures and markets branded food and beverage products in approximately 190 countries, including condiments and sauces, cheese and dairy, meals, meats, beverages, coffee, and snacks. The filing covers the 52-week fiscal year ended December 30, 2017, with comparison to the 52-week year ended December 31, 2016. The company reports United States, Canada, Europe, and Rest of World segments.

For the fourth quarter of 2017, net sales were $6.877 billion, net income attributable to common shareholders was $8.003 billion, and diluted EPS was $6.52. Fourth-quarter earnings were heavily affected by the U.S. Tax Reform benefit.

Financial Performance and Key Metrics

Metric	2017	2016	Change
Net sales	$26.232 billion	$26.487 billion	(1.0%)
Gross profit	$9.703 billion	$9.586 billion	1.2%
Operating income	$6.773 billion	$6.142 billion	10.3%
Net income attributable to common shareholders	$10.999 billion	$3.452 billion	218.6%
Diluted EPS	$8.95	$2.81	218.5%
Adjusted EBITDA	$7.930 billion	$7.778 billion	1.9%
Adjusted EPS	$3.55	$3.33	6.6%

Reported gross margin was approximately 37.0% and operating margin was approximately 25.8%, compared with approximately 36.2% and 23.2%, respectively, in 2016. The reported net margin of approximately 41.9% was not representative of underlying performance because 2017 included an approximately $7.0 billion net tax benefit from the U.S. Tax Reform.

Organic net sales decreased 1.0%, reflecting unfavorable volume/mix of 1.5 percentage points, partially offset by 0.5 percentage points of higher pricing.
U.S. net sales declined 1.5%, while Canada declined 5.2%. Europe increased 1.1% and Rest of World increased 3.9%.
Segment Adjusted EBITDA increased in the United States to $6.001 billion, was flat in Europe at $781 million, and declined in Canada to $639 million and Rest of World to $617 million.
Operating income benefited from lower integration and restructuring expenses, productivity savings, and lower overhead costs, partly offset by higher input costs, lower sales, unfavorable foreign exchange, and lower unrealized commodity-hedge gains.

Cash Flow, Balance Sheet, Debt, and Liquidity

Cash provided by operating activities was $527 million, down from $2.649 billion in 2016. The decrease primarily reflected a $1.2 billion pre-funding contribution to postretirement plans, working-capital effects, lower collections on receivables, and higher bonus payments.
Cash provided by investing activities was $1.156 billion, including $2.286 billion of cash receipts on sold receivables and $1.217 billion of capital expenditures.
Cash used in financing activities was $4.226 billion, including $2.888 billion of common-stock dividends and $2.644 billion of long-term debt repayments.
Cash and cash equivalents were $1.629 billion at year-end, with an additional $140 million of current restricted cash. Approximately $1.1 billion of cash and cash equivalents was held by international subsidiaries.
Total long-term debt, including current maturities, was $31.076 billion, compared with $31.759 billion in 2016. Commercial paper outstanding was $448 million, and no amounts were drawn under the $4.0 billion revolving credit facility.
Approximately $2.5 billion and C$200 million of senior notes mature in the third quarter of 2018. Management expects to use new debt issuances, cash on hand, and operating cash flow to fund these maturities.
Management stated that operating cash flow, securitization programs, commercial paper programs, and the revolving facility should provide sufficient liquidity for working capital, capital expenditures, restructuring, benefit contributions, debt service, and dividends.

Material Changes Versus the Prior Comparable Period

Sales declined modestly, but profitability improved because integration costs fell to $457 million from $1.012 billion and savings initiatives continued.
The Integration Program was substantially completed in 2017. Cumulative pre-tax costs reached $2.055 billion, cumulative savings reached approximately $1.725 billion, and approximately 4,900 of an expected 5,200 positions had been eliminated.
The company recognized an approximately $7.0 billion net tax benefit from the Tax Cuts and Jobs Act, including an estimated $7.5 billion deferred-tax benefit from the lower U.S. corporate rate, partly offset by a $312 million toll charge and approximately $125 million of other tax expenses.
Postretirement benefit liabilities declined substantially after a $1.2 billion pre-funding contribution. Total postretirement contributions were $1.3 billion in 2017.
The company repaid $2.0 billion of senior notes and the $600 million term loan facility, while issuing approximately $1.5 billion of floating-rate notes.
The company restated 2017 interim cash-flow presentations to classify cash receipts on sold receivables as investing activities rather than operating activities. Management remediated the related material weakness in internal control, and both management and the auditor concluded controls were effective at year-end.

Guidance, Outlook, Commentary, and Risks

No formal revenue or earnings guidance is provided in the filing. Management expects 2018 capital expenditures of approximately $850 million, primarily due to the wind-down of integration-related footprint investments.
Expected 2018 pension contributions are approximately $50 million, and expected postretirement benefit contributions are approximately $15 million.
International segment reporting is expected to change in the first quarter of 2018, with Middle East and Africa moving into a new EMEA segment and remaining AMEA operations becoming APAC; historical periods will be restated.
Key risks include weak volume and mix, retailer concentration and bargaining power, e-commerce and private-label competition, commodity and energy inflation, foreign-exchange volatility, international political and economic instability, and the ability to realize remaining cost savings.
Walmart represented approximately 21% of 2017 net sales. The company also faces material customer, supplier, product safety, regulatory, litigation, cybersecurity, pension, and information-technology risks.
Goodwill and indefinite-lived intangible assets totaled approximately $98.5 billion. No goodwill impairment was recorded in 2017, but management noted limited excess fair value in many reporting units and continuing sensitivity to operating performance, discount rates, and growth assumptions. A $49 million non-cash trademark impairment was recorded for nutritional beverages in India.
Venezuela remains subject to highly inflationary accounting, currency controls, and government restrictions. The company recorded a $36 million nonmonetary currency devaluation loss in 2017 and does not expect to make new investments or contributions there.
The filing includes approximately $53.5 billion of contractual obligations, including debt, leases, purchase commitments, and other long-term liabilities. Legal matters are considered ordinary-course and are not expected to have a material adverse effect, although outcomes remain uncertain.

Most Important Facts for Investors to Verify

Separate the approximately $7.0 billion tax benefit from recurring earnings; adjusted EPS of $3.55 provides a more comparable 2017 measure.
Assess whether declining organic sales and unfavorable volume/mix, particularly in the United States and Canada, stabilize or worsen.
Review debt maturities, refinancing plans, interest-rate exposure, and liquidity after the 2018 maturities.
Evaluate the sustainability of integration savings relative to commodity inflation, promotional pressure, and required commercial investment.
Monitor goodwill and trademark impairment sensitivity given the large $98.5 billion balance and limited valuation headroom.
Confirm the final accounting impact of the provisional U.S. Tax Reform estimates when the 2017 tax return is filed.
Review the cash-flow impact of receivables securitization and the 2017 change in cash-flow classification.
Track customer concentration, international currency exposure, Venezuela developments, and the planned EMEA/APAC segment reorganization.