Kraft Heinz Co quarterly report, Q3 FY2020

Kraft Heinz Co. 2020 Q3 Form 10-Q Summary

Business context and reporting period

The filing covers the 13 weeks and 39 weeks ended September 26, 2020, compared with the periods ended September 28, 2019. Kraft Heinz manufactures and markets food and beverage products globally. Its reportable segments are United States, International, and Canada. COVID-19 increased retail and at-home consumption but adversely affected foodservice demand.

Financial performance and key metrics

Metric	Q3 2020	Q3 2019	9M 2020	9M 2019
Net sales	$6.441 billion	$6.076 billion	$19.246 billion	$18.441 billion
Gross profit	$2.344 billion	$1.947 billion	$6.654 billion	$6.040 billion
Operating income/(loss)	$1.147 billion	$1.180 billion	$578 million	$2.476 billion
Net income/(loss) attributable to common shareholders	$597 million	$899 million	$(676) million	$1.753 billion
Diluted EPS	$0.49	$0.74	$(0.55)	$1.43
Adjusted EBITDA	$1.667 billion	$1.469 billion	$4.881 billion	$4.500 billion
Adjusted EPS	$0.70	$0.69	$2.09	$2.13

Q3 net sales increased 6.0%; organic net sales increased 6.3%, driven by pricing of 3.7 percentage points and favorable volume/mix of 2.6 percentage points.
Nine-month net sales increased 4.4%; organic net sales increased 6.7%, driven by favorable volume/mix of 4.1 percentage points and pricing of 2.6 percentage points.
Approximate Q3 margins were 36.4% gross, 17.8% operating, and 9.3% net. Approximate nine-month margins were 34.6% gross, 3.0% operating, and negative 3.5% attributable net margin.
Q3 Adjusted EBITDA rose 13.5% and nine-month Adjusted EBITDA rose 8.5%; these are non-GAAP measures and exclude, among other items, impairment losses and certain restructuring and transaction costs.
Operating cash flow for the first nine months was $3.326 billion, compared with $1.990 billion in the prior-year period. Capital expenditures were $397 million versus $581 million.
Cash, cash equivalents, and restricted cash totaled $2.721 billion at September 26, 2020, including $2.720 billion of cash and cash equivalents. Approximately $1.6 billion of cash and cash equivalents was held by international subsidiaries.
Long-term debt, including the current portion, was $28.411 billion, compared with $29.238 billion at December 28, 2019. Total debt had a carrying value of approximately $28.4 billion and fair value of $30.7 billion.
No commercial paper or revolving credit facility borrowings were outstanding at quarter-end. The company had a $4.0 billion revolving facility, expanded after quarter-end to aggregate commitments of $4.1 billion through July 2023 and $4.0 billion through July 2024.

Material changes versus the prior comparable period

Q3 operating income declined 2.8% and common-shareholder net income declined 33.7%, despite higher sales, primarily because of a $300 million non-cash goodwill impairment related to the planned cheese divestiture, higher compensation and supply-chain costs, and unfavorable commodity costs.
Nine-month operating income fell 76.7% and the company reported a net loss, primarily because impairment losses increased to $3.399 billion from $1.223 billion. The 2020 amount included $2.343 billion of goodwill impairments and $1.056 billion of intangible-asset impairments.
The company recorded approximately $1.8 billion of goodwill impairment in the second quarter related to U.S. Foodservice, Canada Retail, Canada Foodservice, and EMEA East reporting units, and approximately $1.1 billion of brand impairments, including Oscar Mayer and Maxwell House.
Canada remained weak: nine-month reported sales declined 16.3% and Segment Adjusted EBITDA declined 27.7%, primarily due to divestitures, foreign exchange, higher supply-chain costs, and the end of the McCafé licensing agreement. On an organic basis, Canada sales increased 1.0%.
United States nine-month sales increased 7.5% and Segment Adjusted EBITDA increased 13.9%. International sales increased 1.5% and Segment Adjusted EBITDA increased 4.1%.
Other expense/(income) was $73 million of income in Q3 2020 versus $380 million of income in Q3 2019, reflecting the absence of the prior-year $244 million gain on business sales and higher foreign-exchange losses. Nine-month other income declined to $232 million from $893 million, primarily because 2019 included $490 million of divestiture gains.
The company issued $3.5 billion of senior notes in May 2020 and used proceeds for a tender offer, debt redemptions, and related costs. It recognized $109 million of debt prepayment and extinguishment costs during the first nine months.

Guidance, outlook, commentary, and risks

Management expects 2020 capital expenditures of approximately $600 million, compared with $768 million in 2019, although the estimate remains subject to change because of COVID-19.
Management believes operating cash flow and the Senior Credit Facility will provide sufficient liquidity for working capital, debt repayments, dividends, capital expenditures, restructuring costs, and benefit-plan contributions over the next 12 months.
The company expects the approximately $3.3 billion Cheese Transaction with Lactalis, including approximately $3.2 billion of cash consideration, to close in the first half of 2021, subject to customary conditions and regulatory approvals. Management expects to use post-tax proceeds primarily to repay long-term debt.
At closing, Kraft Heinz may record an additional impairment related to the retained portions of the Kraft and Velveeta brands and may recognize a gain or loss on sale. The amount is not yet determinable.
COVID-19 continued to benefit retail demand but reduced foodservice demand. Further restrictions, restaurant closures, shifts toward at-home consumption, supply-chain disruption, labor shortages, input-cost inflation, foreign-exchange volatility, and changes in consumer behavior could adversely affect results.
Additional goodwill or brand impairments remain a material risk. Reporting units and brands with limited excess fair value include approximately $7.5 billion of goodwill with 10% or less excess fair value and approximately $21.8 billion of brands with 10% or less excess fair value after impairment.
Fitch and S&P downgraded the company’s long-term credit rating from BBB- to BB+ in February 2020. The downgrades may increase borrowing costs and limit access to commercial paper markets, although they did not trigger a debt default.
The SEC and the U.S. Attorney’s Office for the Northern District of Illinois continue reviewing matters involving procurement, financial reporting, incentive plans, debt issuances, internal controls, impairment assessments, disclosures, and related issues. The company cannot predict the scope, duration, or outcome.
The company is defending securities, ERISA, and shareholder derivative litigation. The filing states that potential losses cannot reasonably be estimated because the proceedings are at an early stage.
Management stated that disclosure controls and procedures were effective as of September 26, 2020 and that there were no material changes in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether the Lactalis Cheese Transaction closes on schedule, the final cash proceeds, regulatory outcome, and any additional Kraft or Velveeta impairment.
Whether retail demand remains elevated and whether foodservice recovery offsets potential normalization or reversal of pandemic-driven retail sales.
Future impairment sensitivity for foodservice reporting units and major brands, particularly under weaker sales, margin, growth, foreign-exchange, or discount-rate assumptions.
Debt repayment plans, refinancing needs, credit-rating developments, covenant compliance, and the intended use of divestiture proceeds.
The scope and outcome of the SEC and U.S. Attorney investigations and related securities, ERISA, and derivative litigation.
The sustainability of the quarterly $0.40-per-share dividend given leverage, cash generation, planned debt repayment, and changing operating conditions.