Kraft Heinz Co. — 2017 Q3 Form 10-Q Summary
Business Context and Reporting Period
The filing covers the three and nine months ended September 30, 2017, compared with October 2, 2016. Kraft Heinz manufactures and markets food and beverage products globally, including condiments and sauces, cheese and dairy, meals, meats, beverages, coffee, and other grocery products. Reportable segments are the United States, Canada, Europe, and Rest of World.
Financial Performance and Key Metrics
| Metric | Q3 2017 | Q3 2016 | Change | Nine Months 2017 | Nine Months 2016 | Change |
|---|---|---|---|---|---|---|
| Net sales | $6.314 billion | $6.267 billion | 0.7% | $19.355 billion | $19.630 billion | (1.4)% |
| Gross profit | $2.314 billion | $2.218 billion | 4.3% | $7.296 billion | $7.127 billion | 2.4% |
| Gross margin | 36.7% | 35.4% | +130 bps | 37.7% | 36.3% | +140 bps |
| Operating income | $1.661 billion | $1.413 billion | 17.6% | $5.133 billion | $4.562 billion | 12.5% |
| Operating margin | 26.3% | 22.5% | +380 bps | 26.5% | 23.2% | +330 bps |
| Net income attributable to common shareholders | $944 million | $842 million | 12.1% | $2.996 billion | $2.508 billion | 19.5% |
| Diluted EPS | $0.77 | $0.69 | 11.6% | $2.44 | $2.05 | 19.0% |
| Adjusted EBITDA | $1.929 billion | $1.803 billion | 7.0% | $5.915 billion | $5.841 billion | 1.3% |
Q3 organic net sales increased 0.3%, reflecting 0.5 percentage points of pricing growth offset by 0.2 points of unfavorable volume and mix. Nine-month organic net sales declined 1.1%, with a 1.5-point volume and mix decline partially offset by 0.4 points of pricing.
Cash flow from operating activities was $16 million for the nine months, down from $1.016 billion in the prior comparable period. The decline was primarily attributed to lower collections on receivables, timing of taxes, promotional payments, bonuses, and interest, as well as the use of receivables securitization programs. Investing cash flow was $724 million, including $1.633 billion of cash receipts on sold receivables and $956 million of capital expenditures. Financing cash outflow was $3.489 billion, including $2.161 billion of common-stock dividends and net debt repayments.
At September 30, 2017, cash and cash equivalents were $1.441 billion, or $1.549 billion including restricted cash. Long-term debt, including the current portion, was $31.054 billion; commercial paper outstanding was approximately $443 million. The $4.0 billion revolving credit facility had no amounts drawn, and the company reported compliance with debt covenants.
Material Changes Versus the Prior Comparable Period
- Operating income benefited from lower integration and restructuring expenses, cost savings, lower overhead costs, pricing, and favorable currency effects. Integration and restructuring expenses declined to $95 million in Q3 from $237 million and to $237 million for the nine months from $781 million.
- The Integration Program generated cumulative pre-tax savings of approximately $1.575 billion. Management expected total savings of $1.7 billion to $1.8 billion by the end of 2017.
- Nine-month net income benefited from the absence of Series A Preferred Stock dividends, which reduced the prior-year period by $180 million. This benefit was partly offset by higher interest expense of $926 million versus $824 million.
- The United States remained the largest segment. Q3 U.S. sales declined 0.4%, while Segment Adjusted EBITDA increased 6.8%. Rest of World sales increased 1.6%, but nine-month Segment Adjusted EBITDA declined 7.6% due to input costs, commercial investments, and currency effects.
- In the third quarter, Kraft Heinz issued approximately $1.5 billion of floating-rate senior notes due 2019, 2021, and 2022. Proceeds were used primarily to repay a $600 million term loan, refinance commercial paper, and fund general corporate purposes.
- The company recognized a $48 million non-cash impairment loss on an indefinite-lived trademark associated with declining nutritional beverages in India.
- The company announced a planned international segment reorganization effective December 30, 2017, creating Europe, Middle East and Africa and Asia Pacific groupings and requiring historical segment restatement.
Guidance, Outlook, Commentary, and Risks
- Management expected 2017 capital expenditures of approximately $1.1 billion. Total anticipated Integration Program capital expenditures were approximately $1.4 billion, of which $1.2 billion had been incurred through September 30, 2017.
- Management stated that operating cash flow, receivables securitization, commercial paper, and the revolving credit facility should provide sufficient liquidity for working capital, capital expenditures, restructuring, pension contributions, debt obligations, and dividends.
- Commodity cost volatility was expected to continue, particularly for dairy, meat, coffee, and nuts. The company used pricing and risk-management strategies to mitigate these pressures.
- The company continued to consolidate its Venezuelan subsidiary under highly inflationary accounting. It recorded a $36 million nonmonetary currency devaluation loss for the nine months and warned that increased government restrictions or further economic deterioration could affect control of the subsidiary.
- Goodwill totaled $44.858 billion and indefinite-lived intangible assets totaled $53.639 billion. No goodwill impairment was recorded, but management noted that weaker brand or reporting-unit performance, valuation changes, or unfavorable market conditions could lead to future impairment.
- The company identified a material weakness in internal control over financial reporting related to the adoption and application of accounting standards. Prior-quarter financial statements were restated to reclassify cash receipts from sold receivables from operating to investing activities. Disclosure controls were therefore not effective as of September 30, 2017.
- Pending legal matters were not expected to have a material adverse effect, although the filing notes that litigation outcomes cannot be predicted with certainty.
Most Important Facts for Investors to Verify
- Whether the company remediated the material weakness involving accounting-standard adoption and whether further cash-flow or financial-statement restatements are required.
- The sustainability of reported margin expansion and Adjusted EBITDA growth after excluding restructuring gains, integration savings, currency effects, and other non-GAAP adjustments.
- Underlying volume and mix trends, especially the nine-month declines in the United States and Canada and the distribution losses in cheese, meat, nuts, and other categories.
- Liquidity implications of weak operating cash flow, reliance on receivables securitization, approximately $31.1 billion of long-term debt, and floating-rate borrowings.
- Progress toward the $1.7 billion to $1.8 billion Integration Program savings target and the remaining restructuring costs and capital expenditures.
- Potential impairment risk associated with the company’s substantial goodwill and intangible-asset balances, including the underperforming India nutritional-beverage trademark.
- Exposure to commodity inflation, foreign-exchange movements, Venezuela, customer concentration, competitive pressures, and pension and labor costs.