Kraft Heinz Co. — Form 10-Q Summary
Business context and reporting period
The Kraft Heinz Company manufactures and markets food and beverage products globally, including condiments and sauces, cheese and dairy, meals, meats, beverages, coffee, and grocery products. This unaudited Form 10-Q covers the three and nine months ended September 29, 2018, compared with September 30, 2017. The company reports through the United States, Canada, EMEA, and Rest of World segments.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $6,378 million | $6,280 million | $19,368 million | $19,241 million |
| Gross profit | $2,107 million | $2,203 million | $6,717 million | $6,835 million |
| Gross margin | 33.0% | 35.1% | 34.7% | 35.5% |
| Operating income | $1,070 million | $1,538 million | $3,880 million | $4,615 million |
| Operating margin | 16.8% | 24.5% | 20.0% | 24.0% |
| Net income attributable to common shareholders | $630 million | $944 million | $2,379 million | $2,996 million |
| Diluted EPS | $0.51 | $0.77 | $1.94 | $2.44 |
| Adjusted EPS | $0.78 | $0.83 | $2.67 | $2.65 |
| Adjusted EBITDA | $1,616 million | $1,888 million | $5,385 million | $5,797 million |
Net sales increased 1.6% in the quarter and 0.7% year to date. Organic net sales increased 2.6% in the quarter and 0.3% year to date. Quarterly growth was driven by favorable volume and mix of 3.5 percentage points, partly offset by pricing declines of 0.9 percentage points. Year-to-date organic growth reflected pricing increases of 0.5 percentage points, partly offset by unfavorable volume and mix of 0.2 percentage points.
- United States quarterly sales increased 1.8%, but nine-month sales declined 1.2%; Segment Adjusted EBITDA declined 16.2% and 9.9%, respectively.
- Canada quarterly sales declined 5.6%, including a 4.2 percentage-point currency headwind; nine-month sales declined 0.9%.
- EMEA quarterly sales declined 3.3% because of currency and portfolio effects, while nine-month sales increased 6.5%.
- Rest of World sales increased 9.9% in the quarter and 7.8% year to date, although currency depreciation, including Venezuela, was a significant headwind.
Cash flow, liquidity, debt, and capital allocation
- Operating cash flow was $899 million for the first nine months of 2018, compared with $16 million in the prior-year period.
- Investing activities provided $485 million, including $1,296 million of cash receipts on previously sold receivables, partly offset by $594 million of capital expenditures and $248 million for acquisitions.
- Financing activities used $1,658 million, including $2,421 million of common-stock dividends, $2,727 million of long-term debt repayments, and $2,990 million of new long-term debt proceeds.
- Cash, cash equivalents, and restricted cash declined to $1,367 million from $1,769 million at December 30, 2017; cash and cash equivalents alone were $1,366 million.
- Total debt was approximately $32.4 billion at September 29, 2018, consisting of $973 million of commercial paper and other short-term debt, $405 million of current long-term debt, and $30,998 million of long-term debt. Long-term debt, including the current portion, was $31.4 billion.
- Commercial paper outstanding was $971 million, with a weighted-average interest rate of 1.077%. No amounts were drawn under the $4.0 billion revolving credit facility, whose maturity was extended to July 2023.
- Management stated that operating cash flow, cash on hand, commercial paper, and the revolving credit facility should provide sufficient liquidity for working capital, capital expenditures, debt repayments, restructuring, benefit contributions, and dividends.
- Capital expenditures for 2018 were expected to be approximately $850 million. The quarterly dividend remained $0.625 per share; the board subsequently declared a $0.625 dividend payable in December 2018.
Material changes, outlook, risks, and unusual items
- Profitability deteriorated materially: quarterly operating income fell 30.4%, common-shareholder net income fell 33.3%, diluted EPS fell 33.8%, and Adjusted EBITDA fell 14.4%. Management cited higher input costs, strategic investments, overhead, foreign exchange, and impairment charges.
- Impairment charges totaled $234 million in the third quarter and $499 million year to date, including a $215 million Smart Ones brand impairment, a $164 million Australia and New Zealand goodwill impairment, and a $101 million Quero brand impairment.
- Venezuelan currency devaluation losses were $64 million in the quarter and $131 million year to date, compared with $3 million and $36 million, respectively, in the prior-year periods. Further economic deterioration or regulatory changes could affect the company’s ability to control and fund the Venezuelan subsidiary.
- The company incurred $278 million of integration and restructuring expenses year to date, including $90 million related to the North American Integration Program. It expected an insignificant amount of additional Integration Program costs in the fourth quarter and approximately $10 million of related capital expenditures.
- The company acquired Cerebos for approximately $244 million and completed two smaller acquisitions for an aggregate $27 million. It also sold its 50.1% South African interest for $18 million and recorded a $15 million pretax loss.
- On October 24, 2018, the company agreed to sell Heinz India for approximately $625 million, subject to customary closing conditions and regulatory approvals, with closing expected in early 2019. The transaction includes certain brands but not the core Heinz and Kraft brands.
- The company substantially unwound its U.S. and international receivables securitization and factoring programs, replacing much of that funding with long-term debt. This may reduce reliance on receivables financing but increases the importance of debt funding.
- Goodwill and intangible assets totaled approximately $103.0 billion, creating significant exposure to future impairment if sales, margins, cash flows, discount rates, or market conditions deteriorate.
- The company adopted several accounting standards in 2018 and expected the new lease standard, effective in fiscal 2019, to have a significant balance-sheet impact, although the amount was not yet reasonably estimable.
- Management reported no material changes to previously disclosed market risks or risk factors and stated that pending legal matters were not expected to have a material adverse effect, although outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether volume and mix improvements can offset pricing pressure, input-cost inflation, strategic investments, and higher overhead.
- The sustainability of the reported cash-flow improvement, particularly after the wind-down of receivables securitization programs.
- Debt reduction capacity, refinancing requirements, interest-rate exposure, and the effect of the 2018 debt issuance on future interest expense.
- Potential additional impairments affecting the company’s substantial goodwill and brand intangible balances.
- Execution and closing of the Heinz India divestiture and the operational contribution of Cerebos.
- Continuing currency, inflation, regulatory, and operational risks in Venezuela and other international markets.
- Whether the regular dividend remains supported by operating cash flow and leverage levels.