Business Context and Reporting Period
The Kraft Heinz Company filed an unaudited Form 10-Q for the three and six months ended July 3, 2016, compared primarily with June 28, 2015. The July 2015 merger with Kraft Foods Group significantly affects year-over-year comparability; management therefore also presents unaudited pro forma and non-GAAP comparisons assuming the combined company existed throughout the prior-year periods.
Kraft Heinz manufactures and markets food and beverage products globally. Reportable segments are United States, Canada, Europe, and Rest of World.
Key Financial Metrics
| Metric | Three Months Ended July 3, 2016 | Six Months Ended July 3, 2016 |
|---|---|---|
| Net sales | $6.793 billion | $13.363 billion |
| Gross profit | $2.531 billion; 37.3% margin | $4.909 billion; 36.7% margin |
| Operating income | $1.636 billion; 24.1% margin | $3.149 billion; 23.6% margin |
| Net income attributable to Kraft Heinz | $950 million | $1.846 billion |
| Net income attributable to common shareholders | $770 million | $1.666 billion |
| Diluted EPS | $0.63 | $1.36 |
| Adjusted EPS | $0.85 | $1.58 |
| Adjusted EBITDA | $2.087 billion; 30.7% margin | $4.038 billion; 30.2% margin |
| Operating cash flow | Not separately provided for the quarter | $2.104 billion |
Interest expense was $264 million in the quarter and $513 million year to date. The effective tax rate was 30.1% for the quarter and 29.7% for the six-month period.
Cash and cash equivalents were $4.237 billion at July 3, 2016, down from $4.837 billion at January 3, 2016. Capital expenditures were $514 million year to date. Net cash used in investing activities was $516 million, while net cash used in financing activities was $2.189 billion.
Total debt, including the current portion, was approximately $32.753 billion at July 3, 2016, consisting of $30.002 billion of long-term debt, $2.106 billion of current long-term debt, and $645 million of commercial paper and other short-term debt. The filing separately states long-term debt including the current portion of $32.1 billion, reflecting carrying-value presentation. Commercial paper outstanding was $633 million at a weighted average interest rate of 1.129%. No revolving credit facility borrowings were outstanding, and the company reported compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Reported net sales increased 159.7% in the quarter and 162.3% for the six months, primarily because the prior-year periods included only limited post-merger activity. On a pro forma basis, sales decreased 4.7% in the quarter and 4.3% year to date.
- Organic net sales declined 0.5% in the quarter and increased 0.3% year to date. Pricing was favorable, but volume/mix was unfavorable in both periods.
- Adjusted EBITDA increased 17.7% in the quarter and 19.4% year to date, driven by integration savings and favorable pricing net of commodity costs, partially offset by foreign currency headwinds.
- Adjusted EPS increased 39.3% to $0.85 in the quarter and 38.6% to $1.58 year to date on a pro forma basis.
- Operating income included $284 million of integration and restructuring expenses in the quarter and $544 million year to date, compared with $62 million and $105 million, respectively, in the prior-year periods.
- Interest expense declined year over year despite higher debt, principally because the prior-year period included a $227 million loss related to the release of accumulated other comprehensive income from terminated interest-rate swaps and other merger-related effects.
- The company redeemed all $8.320 billion of Series A preferred stock on June 7, 2016, primarily using proceeds from new debt issuances and other liquidity sources. No future Series A preferred dividends are expected.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management expects the Integration Program to generate $1.5 billion of pretax savings by 2017. Approximately $660 million of cumulative savings had been achieved by July 3, 2016, including $310 million in the quarter and $535 million year to date.
- The Integration Program is expected to incur approximately $1.9 billion of pretax costs and approximately $1.1 billion of related capital expenditures. Cumulative program costs were $1.3 billion at July 3, 2016, and $377 million of related capital expenditures had been recognized.
- The company expects 2016 capital expenditures of approximately $1.4 billion. It also expected additional 2016 pension contributions of up to approximately $165 million.
- Management stated that operating cash flow, cash on hand, the revolving credit facility, securitization programs, and commercial paper should provide sufficient liquidity for working capital, integration spending, capital expenditures, pension contributions, contractual obligations, and anticipated dividends.
- Commodity cost volatility is expected to continue. The company relies on pricing and hedging strategies to manage exposure to dairy, meat, coffee, nuts, packaging materials, energy, and other inputs.
- Venezuela remained a significant unusual item and risk. The company recorded a $7 million nonmonetary currency devaluation loss and a $53 million impairment loss on property and equipment and prepaid spare parts in the quarter and year to date. Further deterioration or government restrictions could affect control of the Venezuelan subsidiary and potentially require deconsolidation.
- Goodwill of $44.6 billion and indefinite-lived intangible assets of $53.6 billion were substantial portions of the balance sheet. No impairment was recorded in the 2016 annual tests, but one Rest of World reporting unit and seven brands had estimated fair values less than 10% above carrying values, creating future impairment sensitivity.
- The company disclosed risks involving integration execution, cost-savings realization, foreign exchange, commodity prices, competition, consumer demand, customer concentration, indebtedness, pensions, legal and regulatory matters, product liability, tax law, and information technology.
- The filing states that pending legal matters are not expected to have a material adverse effect. The CFTC wheat-futures matter is predominantly allocated to Mondelēz International under the separation agreement.
- The company declared a $0.60 per-share common dividend payable October 7, 2016, following a $0.575 per-share dividend paid in July. The annualized dividend rate was $2.40 per share, subject to board discretion.
Most Important Facts to Verify
- Reconcile reported results with pro forma and organic measures because the 2015 merger makes reported year-over-year growth rates misleading.
- Assess whether integration savings can reach the stated $1.5 billion target while total program costs and facility closures continue.
- Monitor leverage, refinancing needs, interest costs, and the effect of the $7 billion-plus increase in debt carrying value during the first half of 2016.
- Review cash conversion, inventory buildup ahead of facility closures, receivables securitization, and the sustainability of dividends after the preferred-stock redemption.
- Evaluate goodwill and brand-valuation sensitivity, particularly for the reporting unit and seven brands with less than 10% valuation headroom.
- Track foreign-exchange and operating risks in Venezuela, Europe, Canada, and Rest of World, including potential deconsolidation or further impairment.
- Distinguish GAAP results from management’s non-GAAP Organic Net Sales, Adjusted EBITDA, and Adjusted EPS measures.
- Consider the tax characterization risk disclosed for 2016 distributions, including the possibility that some common-stock distributions may be treated as return of capital rather than dividends for U.S. federal income-tax purposes.