Kraft Heinz Co. — 2016 Q3 Form 10-Q Summary
Business context and reporting period
The filing covers the three and nine months ended October 2, 2016, compared with September 27, 2015. Kraft Heinz manufactures and markets branded food and beverage products globally across four reporting segments: United States, Canada, Europe, and Rest of World. Comparability is affected by the July 2, 2015 merger with Kraft Foods Group; management therefore presents pro forma and non-GAAP measures.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $6.267 billion | $6.120 billion | $19.630 billion | $11.214 billion |
| Pro forma net sales | $6.267 billion | $6.363 billion | $19.630 billion | $20.323 billion |
| Organic net sales | $6.299 billion | $6.361 billion | $19.913 billion | $19.934 billion |
| Operating income | $1.413 billion | $399 million | $4.562 billion | $1.352 billion |
| Net income attributable to common shareholders | $842 million | $(303) million | $2.508 billion | $(551) million |
| Diluted EPS | $0.69 | $(0.27) | $2.05 | $(0.87) |
| Adjusted EBITDA | $1.803 billion | $1.482 billion | $5.841 billion | $4.864 billion |
| Adjusted EPS | $0.83 | $0.44 | $2.41 | $1.57 |
Q3 reported sales increased 2.4%, while pro forma sales declined 1.5% and organic sales declined 1.0%. Nine-month reported sales rose 75.0% because the prior-year period included only part of the post-merger company; pro forma sales declined 3.4% and organic sales declined 0.1%.
- Q3 gross profit was $2.218 billion, implying a gross margin of approximately 35.4%, versus 26.6% in the prior-year quarter.
- Q3 operating margin was approximately 22.5%, versus 6.5% in the prior-year quarter. Nine-month operating margin was approximately 23.2%, versus 12.1%.
- Q3 net income attributable to Kraft Heinz was $842 million; the effective tax rate was 23.7%. The prior-year quarter included a tax benefit and a $180 million preferred dividend.
- Nine-month net cash provided by operating activities was $2.866 billion, compared with $746 million in the prior-year period.
- Capital expenditures were $836 million for the nine months, versus $366 million in the prior-year period.
- Cash used in investing activities was $742 million, compared with $9.401 billion in the prior year, which included the cash acquisition of Kraft Foods Group.
- Cash used in financing activities was $3.024 billion, compared with $11.191 billion of financing cash inflow in the prior year.
- Cash and cash equivalents were $3.920 billion at October 2, 2016, down from $4.837 billion at January 3, 2016.
- Total debt, including current maturities, was approximately $32.0 billion, compared with $25.2 billion at January 3, 2016. Commercial paper outstanding was $639 million at a weighted average rate of 0.925%.
- The company had a $4.0 billion revolving credit facility, no revolver borrowings, and $600 million outstanding under a term loan facility. Management stated that all debt covenants were satisfied.
- Common dividends paid were $2.123 billion during the nine months. The annualized common dividend rate was $2.40 per share. Series A preferred stock was fully redeemed for $8.320 billion on June 7, 2016.
Material changes versus the prior comparable period
- Reported profitability improved substantially, primarily because the prior-year results included non-cash Kraft inventory step-up costs, merger costs, higher restructuring expenses, and debt-related charges.
- Integration and restructuring expenses were $237 million in Q3 and $781 million for the nine months, compared with $482 million and $587 million, respectively, in the prior-year periods.
- The Integration Program is expected to generate $1.5 billion of pretax savings by 2017. Management reported approximately $330 million of savings in Q3, $865 million for the nine months, and approximately $990 million cumulatively since inception.
- The company expects approximately $1.9 billion of total Integration Program costs, including approximately $650 million of organization costs, $1.1 billion of footprint costs, and $150 million of other costs. Approximately 60% is expected to be cash expenditures.
- Management expects to close six factories and eliminate approximately 1,900 positions through footprint activities, while the overall organizational program is expected to eliminate approximately 3,350 positions. Approximately 3,250 affected employees had left by October 2, 2016.
- United States Q3 organic sales declined 1.2%, while Segment Adjusted EBITDA increased 30.6%. Canada organic sales increased 2.0% and EBITDA increased 34.5%. Europe organic sales declined 7.8% and EBITDA declined 17.9%. Rest of World organic sales increased 3.6%, but EBITDA declined 1.3%.
- Management announced that, effective December 31, 2016, the Russia business would move to Europe and the remaining RIMEA businesses would move to Asia Pacific. Segment results were expected to be restated in the fourth quarter.
- Goodwill and indefinite-lived intangible assets totaled approximately $44.5 billion and $53.5 billion, respectively. No impairment was recorded, but certain reporting units and brands had less than 10% excess fair value over carrying value.
- The company recorded a $66 million net increase to accumulated other comprehensive income to correct an immaterial prior-service-credit misstatement related to postretirement benefits.
Guidance, outlook, management commentary, risks and unusual items
- Management expected 2016 capital expenditures of approximately $1.2 billion, including integration and restructuring spending. Integration-related capital expenditures were $581 million through October 2, 2016, against an estimated program requirement of approximately $1.1 billion.
- Management believed operating cash flow, the revolving credit facility, securitization programs, commercial paper, and cash on hand would provide sufficient liquidity for working capital, restructuring, capital expenditures, benefit contributions, contractual obligations, and dividends.
- Commodity cost volatility was expected to continue. Key exposures include dairy, meat, coffee, nuts, tomatoes, potatoes, oils, sugar, packaging materials, and natural gas.
- Venezuela remained subject to severe economic uncertainty, inflation, currency controls, import and pricing restrictions, and potential deconsolidation risk. A $53 million impairment of Venezuelan assets was recorded in the second quarter, and the company had $26 million of outstanding requests for payment of historical invoices at the former official exchange rate.
- The company’s international subsidiaries held approximately $1.6 billion of cash and short-term investments. Management believed approximately $3.7 billion could be remitted to the United States without additional material tax expense, although repatriation of other indefinitely reinvested earnings could create additional tax.
- Principal stated risks include competition, changing consumer preferences, retailer concentration, commodity and currency volatility, failure to realize cost savings, merger integration execution, goodwill and brand impairment, indebtedness, pensions, legal and regulatory matters, product liability, cybersecurity and operational disruptions, and political and economic conditions in international markets.
- Pending legal matters were not expected by management to have a material adverse effect. The CFTC wheat-futures litigation primarily relates to activities attributed to the former Kraft business and is expected to be predominantly borne by Mondelēz under the separation agreement.
- Management concluded that disclosure controls were effective. The filing reported no material changes to internal control over financial reporting, other than transferring certain European Global Business Services processes to third parties without a material change in related controls.
Important facts for investors to verify
- Reconcile reported results with pro forma and organic results because the 2015 merger materially distorts year-over-year comparisons.
- Assess whether organic sales growth, volume/mix, and European performance improve; Q3 organic sales declined 1.0% overall and 7.8% in Europe.
- Track realization of the stated $1.5 billion Integration Program savings target against remaining restructuring costs, factory closures, workforce reductions, and planned capital expenditures.
- Evaluate leverage and refinancing exposure following the increase in debt to approximately $32.0 billion and the $8.320 billion preferred-stock redemption.
- Monitor cash conversion, inventory buildup ahead of facility closures, receivables securitization, and the decline in cash balances.
- Review impairment sensitivity for the $44.5 billion goodwill balance and $53.5 billion indefinite-lived intangible asset balance, particularly for brands and reporting units with limited valuation headroom.
- Confirm the effect of currency controls, inflation, and potential deconsolidation in Venezuela, as well as ongoing commodity and foreign-exchange volatility.
- Distinguish GAAP earnings from Adjusted EBITDA and Adjusted EPS, which exclude restructuring, merger, impairment, hedge, currency, and other specified items.