Kraft Heinz Co quarterly report, Q2 FY2017

Kraft Heinz Co. 2017 Q2 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. The filing covers the three and six months ended July 1, 2017, compared with the periods ended July 3, 2016. Reportable segments are United States, Canada, Europe, and Rest of World. The interim financial statements are unaudited.

Key Financial Metrics

Metric	Three Months Ended July 1, 2017	Three Months Ended July 3, 2016	Six Months Ended July 1, 2017	Six Months Ended July 3, 2016
Net sales	$6.677 billion	$6.793 billion	$13.041 billion	$13.363 billion
Operating income	$1.921 billion	$1.636 billion	$3.472 billion	$3.149 billion
Net income attributable to common shareholders	$1.159 billion	$770 million	$2.052 billion	$1.666 billion
Diluted EPS	$0.94	$0.63	$1.67	$1.36
Adjusted EBITDA	$2.101 billion	$2.087 billion	$3.986 billion	$4.038 billion
Operating cash flow	Not separately provided	Not separately provided	$891 million	$2.104 billion

Second-quarter gross profit was $2.681 billion, implying a gross margin of approximately 40.1%, compared with 37.3% in the prior-year quarter.
Second-quarter operating margin was approximately 28.8%, compared with 24.1% in the prior-year quarter. The six-month operating margin was approximately 26.6%, compared with 23.6%.
Second-quarter net income attributable to common shareholders represented approximately 17.4% of sales, compared with 11.3% in the prior-year quarter.
Cash and cash equivalents were $1.445 billion at July 1, 2017, or $1.518 billion including restricted cash, versus $4.204 billion and $4.255 billion, respectively, at December 31, 2016.
Total debt was approximately $31.1 billion at carrying value, including $1.1 billion of commercial paper, $19 million of current long-term debt, and $30.0 billion of long-term debt including the current portion. Fair value of total debt was $32.3 billion.
The company had $4.0 billion of revolving credit capacity and a $600 million term loan facility; the term loan was fully outstanding and no revolving credit amounts were drawn.
Common dividends declared were $0.60 per share for the quarter and $1.20 per share for the six months. Common dividends paid during the six months were $1.434 billion.

Material Changes Versus the Prior Comparable Period

Net sales declined 1.7% in the quarter and 2.4% for the six months. Organic net sales declined 0.9% and 1.8%, respectively, driven primarily by unfavorable volume/mix, with foreign currency also reducing reported sales.
Operating income increased 17.5% in the quarter and 10.3% for the six months, principally because integration and restructuring costs were substantially lower than in 2016.
Adjusted EBITDA increased 0.7% in the quarter but declined 1.3% for the six months, reflecting lower organic sales, higher local-currency input costs, foreign-exchange pressure, and higher commercial investments.
Net income attributable to common shareholders rose 50.5% in the quarter and 23.2% for the six months. The comparison benefited from the absence of Series A preferred dividends after the June 2016 redemption and from a lower effective tax rate, partly offset by higher interest expense.
Interest expense increased to $307 million in the quarter and $620 million for the six months, compared with $264 million and $513 million, respectively.
Operating cash flow fell to $891 million from $2.104 billion. Management attributed the decline to the timing of promotional, tax, and bonus payments; higher inventory costs; and reduced cash consideration from receivables programs.
The company repaid approximately $2.0 billion of senior notes that matured in the second quarter, primarily using cash on hand and commercial paper. Commercial paper outstanding increased to $1.1 billion from $642 million at year-end.
Segment performance was mixed: United States Segment Adjusted EBITDA increased 3.2% in the quarter and 0.9% for the six months, while Canada, Europe, and Rest of World declined in both periods.

Guidance, Outlook, Risks, Contingencies, and Unusual Items

Management expects 2017 capital expenditures of approximately $1.2 billion, including integration and restructuring expenditures. The Integration Program is expected to require approximately $1.3 billion of capital expenditures in total; $1.2 billion had been incurred by July 1, 2017.
The Integration Program is expected to generate $1.7 billion of pre-tax savings by the end of 2017. Cumulative savings were approximately $1.45 billion as of the filing date. The program is expected to incur approximately $2.0 billion of pre-tax costs, of which approximately $1.8 billion had been incurred.
The program is expected to eliminate 5,150 positions and close six net factories. By July 1, 2017, approximately 4,100 employees had left and five net factories had been closed.
Second-quarter integration and restructuring results included a $168 million postretirement-plan curtailment gain, resulting in a net gain of $6 million for total integration and restructuring activities. The gain was unusual and materially benefited reported operating income.
The company recorded a $48 million non-cash impairment loss on an indefinite-lived trademark related to continued declines in nutritional beverages in India.
Venezuelan operations generated a nonmonetary currency devaluation loss of $25 million in the quarter and $33 million for the six months. Continued currency deterioration, government controls, and possible future deconsolidation remain risks.
Key commodities, including cheese, coffee, and meat, experienced cost increases during the six months. Management expects commodity-cost volatility to continue and intends to manage it through pricing and risk-management activities.
The company expects approximately $150 million of additional U.S. pension contributions and $40 million of additional non-U.S. contributions during the remainder of 2017, subject to changes in regulatory, tax, benefit, market, and other conditions.
Management stated that operating cash flow, receivables programs, commercial paper, and available credit facilities should provide sufficient liquidity for working capital, capital expenditures, restructuring, pension contributions, debt repayments, and dividends.
Legal matters, including a CFTC wheat-trading complaint related to pre-existing Kraft activities, are not expected by management to have a material adverse effect. The filing states that no material changes occurred to previously disclosed risk factors or off-balance-sheet arrangements.
Future performance remains exposed to competition, consumer demand, retailer concentration, commodity and foreign-exchange volatility, indebtedness, goodwill and brand impairments, integration execution, pension costs, legal and regulatory matters, product liability, cybersecurity, and economic or political conditions.

Most Important Facts for Investors to Verify

Whether declining organic sales and unfavorable volume/mix improve after the second quarter, particularly in the United States, Canada, and Europe.
Whether Integration Program savings reach the $1.7 billion year-end target without additional cost overruns or operational disruption.
The sustainability of reported margin and EPS gains after excluding the unusual postretirement curtailment gain, lower restructuring charges, preferred-dividend comparison benefit, and tax discrete items.
Whether operating cash flow recovers from the six-month decline and whether working-capital needs increase as inventory and promotional spending remain elevated.
Progress in reducing debt and commercial paper reliance while maintaining dividend payments and funding planned capital expenditures.
Potential future impairment of the approximately $44.6 billion goodwill balance and $53.5 billion of indefinite-lived intangible assets, particularly if brand or reporting-unit performance weakens.
Developments in Venezuela, commodity costs, foreign-exchange rates, pension contributions, and outstanding legal or regulatory matters.