Kraft Heinz Company: FY2015 Form 10-K Summary
Business context and reporting period
The filing covers the 53-week fiscal year ended January 3, 2016. Kraft Heinz manufactures and markets branded food and beverage products in more than 190 countries, including Heinz, Kraft, Oscar Mayer, Planters, Philadelphia, Velveeta, Lunchables, Maxwell House, Capri Sun and Ore-Ida.
The July 2, 2015 merger with Kraft Foods Group materially changed the company’s scale, capital structure and comparability. Fiscal 2015 includes a full year of Heinz results and Kraft results after the merger; fiscal 2014 reflects Heinz only. Management therefore emphasizes unaudited pro forma comparisons that assume the merger occurred at the beginning of fiscal 2014.
Financial performance and key metrics
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Reported net sales | $18.338 billion | $10.922 billion | 67.9% |
| Reported operating income | $2.639 billion | $1.568 billion | 68.3% |
| Net income from continuing operations | $647 million | $672 million | Down $25 million |
| Net income attributable to Kraft Heinz | $634 million | $657 million | Down $23 million |
| Net loss attributable to common shareholders | $(266) million | $(63) million | Higher loss |
| Diluted loss per share | $(0.34) | $(0.17) | Higher loss |
| Cash flow from operations | $2.467 billion | $2.140 billion | Up $327 million |
| Capital expenditures | $648 million | $399 million | Up $249 million |
| Cash and cash equivalents | $4.837 billion | $2.298 billion | Up $2.539 billion |
| Long-term debt | $25.151 billion | $13.358 billion | Up $11.793 billion |
Reported gross profit was $5.761 billion, implying a reported gross margin of approximately 31.4%, versus approximately 30.0% in fiscal 2014. Reported operating margin was approximately 14.4%, versus approximately 14.4% in fiscal 2014. These reported margins are significantly affected by merger accounting, inventory step-up and restructuring costs.
On a pro forma basis, net sales declined 5.8% to $27.447 billion, while pro forma operating income increased 3.5% to $4.535 billion. Pro forma gross margin was approximately 33.3%, compared with 30.8% in fiscal 2014. Adjusted Pro Forma EBITDA increased 3.3% to $6.739 billion, and Adjusted Pro Forma EPS increased 10.6% to $2.19 from $1.98.
Pro Forma Organic Net Sales declined 1.6%, reflecting unfavorable volume and mix of 2.6 percentage points, partly offset by higher net pricing of 1.0 percentage point. Currency reduced pro forma sales by 5.2 percentage points, while the additional 53rd week contributed 1.2 percentage points.
Segments and material changes
- United States: Pro forma sales decreased 1.8% to $19.284 billion; Pro Forma Organic Net Sales declined 3.0%. Segment Adjusted EBITDA increased 6.3% to $4.783 billion.
- Canada: Pro forma sales decreased 15.1% to $2.386 billion, principally due to currency; organic sales declined 2.8%. Segment Adjusted EBITDA decreased 12.0% to $541 million.
- Europe: Sales decreased 16.4% to $2.485 billion, including currency and divestiture effects. Segment Adjusted EBITDA increased 1.2% to $909 million.
- Rest of World: Sales decreased 11.1% to $3.292 billion due mainly to currency, including Venezuela. Organic sales increased 9.2%, while Segment Adjusted EBITDA declined 2.8% to $670 million.
Wal-Mart represented approximately 20% of fiscal 2015 net sales, compared with approximately 10% in fiscal 2014, increasing customer concentration risk.
Cash flow, debt and liquidity
- Operating cash flow was $2.467 billion. Investing cash flow used $9.704 billion, including $9.468 billion for the Kraft acquisition and $648 million of capital expenditures.
- Financing cash flow provided $10.183 billion, including $10.0 billion issued to the Sponsors and $14.834 billion of long-term debt issuance, partly offset by $12.314 billion of debt repayments and $2.202 billion of dividends.
- The company had $25.151 billion of long-term debt, including $600 million outstanding under its term loan facility. No amounts were drawn on the $4.0 billion revolving credit facility at year-end.
- The company was in compliance with all debt covenants at January 3, 2016. Contractual obligations totaled $51.205 billion, including debt, leases, purchase obligations and preferred dividends.
- Series A Preferred Stock totaled $8.320 billion and carries a 9.00% annual dividend. Cash distributions were $900 million in fiscal 2015, including five quarterly payments.
Outlook, management commentary, risks and unusual items
- The company expected 2016 capital expenditures of approximately $1.6 billion, including integration and restructuring requirements.
- The multi-year $1.9 billion Integration Program is expected to generate $1.5 billion of pre-tax savings by 2017. The company incurred $829 million of program costs in fiscal 2015, recognized approximately $125 million of pre-tax savings, and expects approximately 60% of program costs to be cash expenditures.
- The program includes elimination of approximately 2,650 salaried positions and approximately 2,600 positions associated with seven factory closures and distribution consolidation.
- Commodity cost volatility was expected to continue in 2016. The company manages exposure through pricing, hedging and procurement, but does not fully hedge commodity costs.
- Interest expense increased to $1.321 billion, including a $236 million write-off of debt issuance costs and a $227 million charge from terminating interest-rate swaps. Other expense included a $234 million Venezuela currency devaluation charge and $105 million of refinancing call premiums.
- Venezuela was remeasured at the SIMADI rate in June 2015, resulting in a $234 million devaluation charge and a $49 million inventory write-down. Management warned that government controls and economic conditions could eventually affect control of the subsidiary and require deconsolidation.
- The company recorded $58 million of indefinite-lived intangible-asset impairment. Goodwill totaled $43.051 billion and indefinite-lived intangible assets totaled $55.824 billion; much of the Kraft purchase accounting remained preliminary and is sensitive to future impairment testing.
- The company intended to refinance the Series A Preferred Stock in 2016, but stated that completion was not assured.
- Key risks include integration execution, substantial leverage, customer concentration, retailer bargaining power, weak volume and mix, foreign exchange, commodity prices, regulatory and product-liability exposure, cybersecurity, pension obligations, and potential goodwill or brand impairments.
- Pending legal matters included CFTC litigation relating to historical wheat futures activity and merger-related shareholder litigation. Management did not expect either matter to have a material adverse effect.
Important facts for investors to verify
- Reconcile reported results with the unaudited pro forma and non-GAAP measures; reported fiscal 2015 comparisons are not directly comparable because Kraft was consolidated only after July 2, 2015.
- Verify the timing, cash cost and realized savings of the Integration Program, including facility closures and workforce reductions.
- Assess debt maturities, refinancing needs, covenant requirements and the planned refinancing or redemption of the $8.0 billion Series A Preferred Stock.
- Monitor organic volume and mix, particularly in the United States and Canada, where pro forma sales declined despite pricing actions.
- Evaluate the sustainability of reported earnings after excluding merger costs, restructuring, inventory step-up, Venezuela devaluation, impairment and refinancing charges.
- Review goodwill and brand valuation assumptions, especially reporting units and brands with limited fair-value cushions.
- Consider exposure to Wal-Mart, foreign currency, Venezuela, commodity prices, pensions and international cash repatriation taxes.