Business Context and Reporting Period
The Kraft Heinz Company is a global food and beverage manufacturer with brands including Kraft, Heinz, Oscar Mayer, Philadelphia, Velveeta, Planters, Maxwell House, and Lunchables. The filing is a Form 10-K for the 52-week fiscal year ended December 29, 2018, filed June 7, 2019. Results are reported across the United States, Canada, EMEA, and Rest of World segments.
The filing restates selected 2017, 2016, and interim 2018 information following an investigation into supplier contracts and procurement accounting. The auditor issued an unqualified opinion on the financial statements but concluded that internal control over financial reporting was not effective because of material weaknesses.
Key Financial Metrics
| Metric | FY 2018 | FY 2017, restated/recast | Change |
|---|---|---|---|
| Net sales | $26.268 billion | $26.076 billion | +0.7% |
| Gross profit | $8.921 billion | $9.033 billion | Gross margin approximately 34.0% versus 34.6% |
| Operating income/(loss) | $(10.220) billion | $6.057 billion | Primarily affected by impairments |
| Net income/(loss) attributable to common shareholders | $(10.192) billion | $10.941 billion | Down $21.133 billion |
| Diluted EPS | $(8.36) | $8.91 | Down $17.27 |
| Adjusted EBITDA | $7.024 billion | $7.664 billion | Down 8.3% |
| Adjusted EPS | $3.51 | $3.50 | Up 0.3% |
| Cash flow from operations | $2.574 billion | $501 million | Improved by $2.073 billion |
| Capital expenditures | $826 million | $1.194 billion | Down $368 million |
| Cash and cash equivalents | $1.130 billion | $1.629 billion | Down $499 million |
| Total long-term debt, including current portion | $31.147 billion | $31.041 billion | Broadly stable |
FY 2018 net sales growth was supported by 0.9% organic growth, driven by favorable volume/mix; pricing was flat, while currency reduced reported sales by 0.6 percentage points. Approximately 31% of sales were generated outside the United States, and Walmart represented approximately 21% of consolidated sales.
Fourth-quarter net sales were $6.891 billion, compared with $6.841 billion in the prior-year quarter. Fourth-quarter net loss attributable to common shareholders was $12.568 billion, diluted EPS was $(10.30), Adjusted EBITDA was $1.674 billion, and Adjusted EPS was $0.84.
Material Changes Versus the Prior Comparable Period
- FY 2018 included $15.936 billion of goodwill and intangible-asset impairment losses, compared with $49 million in 2017. Fourth-quarter impairment losses were approximately $15.5 billion, including $6.9 billion of goodwill impairments and $8.6 billion of indefinite-lived intangible-asset impairments.
- Major impairment charges included U.S. Refrigerated, Canada Retail, Southeast Asia, Northeast Asia, and Other Latin America reporting units, together with the Kraft, Oscar Mayer, Philadelphia, Velveeta, and ABC brands.
- Adjusted EBITDA declined due to higher input and supply-chain costs, strategic investments, higher overhead, and unfavorable currency effects. U.S. Segment Adjusted EBITDA declined 11.2%; EMEA increased 7.6% and Rest of World increased 7.5%.
- Operating cash flow increased substantially, partly because 2017 included approximately $1.2 billion of postretirement plan prefunding and because 2018 had more cash collections on trade receivables following the unwind of receivables programs.
- The company issued $3.0 billion of senior notes in June 2018, repaid approximately $2.7 billion of maturing senior notes, and ended the year with no commercial paper outstanding.
- Common dividends paid increased to $3.183 billion from $2.888 billion; the annual dividend rate was $2.50 per share versus $2.45 in 2017.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected 2019 capital expenditures of approximately $800 million. The filing does not provide clear full-year 2019 revenue or earnings guidance, but the 2019 operating plan reflected lower growth and margin expectations.
- Assets held for sale totaled $1.376 billion at year-end, principally related to the planned Heinz India divestiture and the Canada natural cheese transaction. Heinz India closed January 30, 2019; the Canada transaction was expected to close in mid-2019.
- The company received an SEC subpoena concerning procurement accounting, supplier agreements, rebates, incentives, and internal controls. The SEC investigation remained unresolved, and the U.S. Attorney’s Office for the Northern District of Illinois was also reviewing the matter.
- The internal investigation identified misconduct by multiple procurement employees. The company corrected $208 million of cumulative cost-of-products-sold understatement, including $22 million related to 2018 and $94 million related to 2017. Management stated that no senior management misconduct was identified.
- The company identified material weaknesses in risk assessment, supplier-contract accounting, and the precision of goodwill and indefinite-lived intangible-asset impairment controls. Disclosure controls were therefore ineffective as of December 29, 2018. Remediation was in progress and was not yet complete.
- The company was late filing its periodic reports and temporarily violated reporting covenants under its senior credit facility and certain indentures. Lenders granted waivers. Failure to meet future reporting deadlines could restrict credit-facility access or cause debt to become callable.
- Long-term debt contractual cash payments totaled $48.251 billion, including interest, and total contractual obligations were $53.052 billion. Principal maturities included approximately $355 million in 2019 and $2.992 billion in 2020.
- Three securities class actions, one ERISA class action, and five stockholder derivative actions were pending in connection with the reporting, control, and procurement matters. The company could not reasonably estimate potential losses.
- Goodwill and brand balances remained highly sensitive to assumptions. Reporting units with heightened impairment risk had $29.0 billion of goodwill, and brands with heightened risk had $29.3 billion of carrying value.
- Management announced that CEO Bernardo Hees would leave the company in 2019; Miguel Patricio was appointed incoming CEO.
Most Important Facts for Investors to Verify
- Whether the SEC and related governmental reviews result in penalties, settlements, further restatements, or additional control requirements.
- Whether remediation of the identified material weaknesses is completed and independently validated.
- Whether weak organic growth, private-label competition, pricing pressure, and supply-chain costs continue to reduce margins and Adjusted EBITDA.
- Whether additional goodwill or brand impairments occur, particularly for reporting units and brands with zero or limited excess fair value.
- Whether the company generates sufficient operating cash flow to fund approximately $31.1 billion of debt, near-term maturities, dividends, capital expenditures, and restructuring obligations.
- The closing proceeds, timing, and final gain or loss from the Canada and Heinz India divestitures.
- Whether reporting compliance is maintained, including timely filing of subsequent Form 10-Q reports and continued Nasdaq listing compliance.
- The comparability of future results given the restatement, adoption of accounting standards, segment reorganization, and extensive use of non-GAAP measures.