Kraft Heinz Co - Quarter Report: 2016 July (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended July 3, 2016
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission File Number 001-37482

The Kraft Heinz Company
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 46-2078182 (I.R.S. Employer Identification No.) | |
One PPG Place, Pittsburgh, Pennsylvania (Address of Principal Executive Offices) | 15222 (Zip Code) |
Registrant’s telephone number, including area code: (412) 456-5700
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer x (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of July 31, 2016, there were 1,217,650,866 shares of the registrant's common stock outstanding.
The Kraft Heinz Company
Table of Contents
Page No. | |
Unless the context otherwise requires, the terms “we,” “us,” “our,” “Kraft Heinz,” and the “Company” each refer to The Kraft Heinz Company.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements and Supplementary Data.
The Kraft Heinz Company
Condensed Consolidated Statements of Income
(in millions, except per share data)
(Unaudited)
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
Net sales | $ | 6,793 | $ | 2,616 | $ | 13,363 | $ | 5,094 | |||||||
Cost of products sold | 4,262 | 1,734 | 8,454 | 3,365 | |||||||||||
Gross profit | 2,531 | 882 | 4,909 | 1,729 | |||||||||||
Selling, general and administrative expenses | 895 | 438 | 1,760 | 776 | |||||||||||
Operating income | 1,636 | 444 | 3,149 | 953 | |||||||||||
Interest expense | 264 | 394 | 513 | 595 | |||||||||||
Other expense/(income), net | 6 | 245 | (2 | ) | 206 | ||||||||||
Income/(loss) before income taxes | 1,366 | (195 | ) | 2,638 | 152 | ||||||||||
Provision for/(benefit from) income taxes | 411 | (35 | ) | 783 | 33 | ||||||||||
Net income/(loss) | 955 | (160 | ) | 1,855 | 119 | ||||||||||
Net income/(loss) attributable to noncontrolling interest | 5 | 4 | 9 | 7 | |||||||||||
Net income/(loss) attributable to Kraft Heinz | 950 | (164 | ) | 1,846 | 112 | ||||||||||
Preferred dividends | 180 | 180 | 180 | 360 | |||||||||||
Net income/(loss) attributable to common shareholders | $ | 770 | $ | (344 | ) | $ | 1,666 | $ | (248 | ) | |||||
Per share data applicable to common shareholders: | |||||||||||||||
Basic earnings/(loss) | $ | 0.63 | $ | (0.91 | ) | $ | 1.37 | $ | (0.66 | ) | |||||
Diluted earnings/(loss) | 0.63 | (0.91 | ) | 1.36 | (0.66 | ) | |||||||||
Dividends declared | 0.575 | — | 1.15 | — |
See accompanying notes to the condensed consolidated financial statements.
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The Kraft Heinz Company
Condensed Consolidated Statements of Comprehensive Income
(in millions)
(Unaudited)
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
Net income/(loss) | $ | 955 | $ | (160 | ) | $ | 1,855 | $ | 119 | ||||||
Other comprehensive income/(loss), net of tax: | |||||||||||||||
Foreign currency translation adjustments | (418 | ) | 361 | (146 | ) | (433 | ) | ||||||||
Net deferred gains/(losses) on net investment hedges | 105 | (206 | ) | 45 | 226 | ||||||||||
Net actuarial gains/(losses) arising during the period | — | (18 | ) | — | (19 | ) | |||||||||
Reclassification of net postemployment benefit losses/(gains) | (50 | ) | 8 | (104 | ) | 7 | |||||||||
Net deferred gains/(losses) on cash flow hedges | (14 | ) | (10 | ) | (32 | ) | (77 | ) | |||||||
Net deferred losses/(gains) on cash flow hedges reclassified to net income | 4 | 137 | (18 | ) | 138 | ||||||||||
Total other comprehensive income/(loss) | (373 | ) | 272 | (255 | ) | (158 | ) | ||||||||
Total comprehensive income/(loss) | 582 | 112 | 1,600 | (39 | ) | ||||||||||
Comprehensive income/(loss) attributable to noncontrolling interest | 5 | 5 | 16 | (6 | ) | ||||||||||
Comprehensive income/(loss) attributable to Kraft Heinz | $ | 577 | $ | 107 | $ | 1,584 | $ | (33 | ) |
See accompanying notes to the condensed consolidated financial statements.
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The Kraft Heinz Company
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
July 3, 2016 | January 3, 2016 | ||||||
ASSETS | |||||||
Cash and cash equivalents | $ | 4,237 | $ | 4,837 | |||
Trade receivables (net of allowances of $32 at July 3, 2016 and at January 3, 2016) | 1,114 | 871 | |||||
Sold receivables | 146 | 583 | |||||
Inventories | 2,881 | 2,618 | |||||
Other current assets | 969 | 871 | |||||
Total current assets | 9,347 | 9,780 | |||||
Property, plant and equipment, net | 6,423 | 6,524 | |||||
Goodwill | 44,641 | 43,051 | |||||
Intangible assets, net | 59,762 | 62,120 | |||||
Other assets | 1,511 | 1,498 | |||||
TOTAL ASSETS | $ | 121,684 | $ | 122,973 | |||
LIABILITIES AND EQUITY | |||||||
Commercial paper and other short-term debt | $ | 645 | $ | 4 | |||
Current portion of long-term debt | 2,106 | 79 | |||||
Trade payables | 2,960 | 2,844 | |||||
Accrued marketing | 867 | 856 | |||||
Accrued postemployment costs | 164 | 328 | |||||
Income taxes payable | 368 | 417 | |||||
Interest payable | 393 | 401 | |||||
Dividends payable | 827 | 762 | |||||
Other current liabilities | 1,263 | 1,241 | |||||
Total current liabilities | 9,593 | 6,932 | |||||
Long-term debt | 30,002 | 25,151 | |||||
Deferred income taxes | 20,900 | 21,497 | |||||
Accrued postemployment costs | 2,341 | 2,405 | |||||
Other liabilities | 801 | 752 | |||||
TOTAL LIABILITIES | 63,637 | 56,737 | |||||
Commitments and Contingencies (Note 12) | |||||||
Redeemable noncontrolling interest | — | 23 | |||||
9.00% cumulative compounding preferred stock, Series A, no shares authorized and issued at July 3, 2016 and 80,000 authorized and issued shares at January 3, 2016, $.01 par value | — | 8,320 | |||||
Equity: | |||||||
Common stock, $.01 par value (5,000,000,000 shares authorized at July 3, 2016 and January 3, 2016; 1,217,900,434 shares issued and 1,217,354,448 shares outstanding at July 3, 2016; 1,214,391,614 shares issued and 1,213,978,752 shares outstanding at January 3, 2016) | 12 | 12 | |||||
Additional paid-in capital | 58,525 | 58,375 | |||||
Retained earnings/(deficit) | 263 | — | |||||
Accumulated other comprehensive income/(losses) | (933 | ) | (671 | ) | |||
Treasury stock, at cost | (41 | ) | (31 | ) | |||
Total shareholders' equity | 57,826 | 57,685 | |||||
Noncontrolling interest | 221 | 208 | |||||
TOTAL EQUITY | 58,047 | 57,893 | |||||
TOTAL LIABILITIES AND EQUITY | $ | 121,684 | $ | 122,973 |
See accompanying notes to the condensed consolidated financial statements.
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The Kraft Heinz Company
Condensed Consolidated Statement of Equity
(in millions)
(Unaudited)
Common Stock | Additional Paid-in Capital | Retained Earnings/ (Deficit) | Accumulated Other Comprehensive Income/(Losses) | Treasury Stock | Noncontrolling Interest | Total Equity | |||||||||||||||||||||
Balance at January 3, 2016 | $ | 12 | $ | 58,375 | $ | — | $ | (671 | ) | $ | (31 | ) | $ | 208 | $ | 57,893 | |||||||||||
Net income/(loss) excluding redeemable noncontrolling interest | — | — | 1,846 | — | — | 9 | 1,855 | ||||||||||||||||||||
Other comprehensive income/(loss) excluding redeemable noncontrolling interest | — | — | — | (262 | ) | — | 4 | (258 | ) | ||||||||||||||||||
Dividends declared-Series A Preferred Stock | — | — | (180 | ) | — | — | — | (180 | ) | ||||||||||||||||||
Dividends declared-common stock | — | — | (1,399 | ) | — | — | — | (1,399 | ) | ||||||||||||||||||
Exercise of stock options, issuance of other stock awards, and other | — | 150 | (4 | ) | — | (10 | ) | — | 136 | ||||||||||||||||||
Balance at July 3, 2016 | $ | 12 | $ | 58,525 | $ | 263 | $ | (933 | ) | $ | (41 | ) | $ | 221 | $ | 58,047 |
See accompanying notes to the condensed consolidated financial statements.
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The Kraft Heinz Company
Condensed Consolidated Statements of Cash Flows
(in millions)
(Unaudited)
For the Six Months Ended | |||||||
July 3, 2016 | June 28, 2015 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net income/(loss) | $ | 1,855 | $ | 119 | |||
Adjustments to reconcile net income/(loss) to operating cash flows: | |||||||
Depreciation and amortization | 720 | 179 | |||||
Amortization of postretirement benefit plans prior service credits | (131 | ) | (3 | ) | |||
Equity award compensation expense | 26 | 5 | |||||
Deferred income tax provision | 3 | (254 | ) | ||||
Pension contributions | (177 | ) | (33 | ) | |||
Nonmonetary currency devaluation | 16 | 234 | |||||
Other items, net | (113 | ) | 334 | ||||
Changes in current assets and liabilities: | |||||||
Trade receivables | (226 | ) | (35 | ) | |||
Sold receivables | 437 | 32 | |||||
Inventories | (256 | ) | (80 | ) | |||
Accounts payable | 90 | 13 | |||||
Other current assets | (68 | ) | (69 | ) | |||
Other current liabilities | (72 | ) | (31 | ) | |||
Net cash provided by/(used for) operating activities | 2,104 | 411 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Capital expenditures | (514 | ) | (163 | ) | |||
Proceeds from net investment hedges | 77 | 306 | |||||
Other investing activities, net | (79 | ) | 7 | ||||
Net cash provided by/(used for) investing activities | (516 | ) | 150 | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Repayments of long-term debt | (12 | ) | (1,963 | ) | |||
Proceeds from issuance of long-term debt | 6,982 | 2,000 | |||||
Proceeds from issuance of commercial paper | 1,939 | — | |||||
Repayments of commercial paper | (1,307 | ) | — | ||||
Dividends paid-Series A Preferred Stock | (180 | ) | (360 | ) | |||
Dividends paid-common stock | (1,334 | ) | — | ||||
Redemption of Series A Preferred Stock | (8,320 | ) | — | ||||
Other financing activities, net | 43 | (56 | ) | ||||
Net cash provided by/(used for) financing activities | (2,189 | ) | (379 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | 1 | (333 | ) | ||||
Cash and cash equivalents: | |||||||
Net increase/(decrease) | (600 | ) | (151 | ) | |||
Balance at beginning of period | 4,837 | 2,298 | |||||
Balance at end of period | $ | 4,237 | $ | 2,147 |
See accompanying notes to the condensed consolidated financial statements.
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The Kraft Heinz Company
Notes to Condensed Consolidated Financial Statements
Note 1. Background and Basis of Presentation
Basis of Presentation:
Our interim condensed consolidated financial statements are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted, in accordance with the rules of the Securities and Exchange Commission (the “SEC”). In management's opinion, these interim financial statements include all adjustments (consisting only of normal recurring adjustments) and accruals necessary to present fairly our results for the periods presented.
The condensed consolidated balance sheet data at January 3, 2016 was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. You should read these statements in conjunction with our audited consolidated financial statements and related notes in our Annual Report on Form 10-K for the year ended January 3, 2016. The results for interim periods are not necessarily indicative of future or annual results.
Organization:
On July 2, 2015 (the “2015 Merger Date”), through a series of transactions, we consummated the merger of Kraft Foods Group, Inc. (“Kraft”) with and into a wholly-owned subsidiary of H.J. Heinz Holding Corporation (“Heinz”) (the “2015 Merger”). At the closing of the 2015 Merger, Heinz was renamed The Kraft Heinz Company (“Kraft Heinz”).
Before the consummation of the 2015 Merger, Heinz was controlled by Berkshire Hathaway Inc. and 3G Global Food Holdings, L.P. (together, the “Sponsors”).
Changes in Accounting and Reporting:
In the third quarter of 2015, we made the following changes in accounting and reporting to harmonize our accounting and reporting as Kraft Heinz:
• | We made a voluntary change in accounting policy to classify certain warehouse and distribution costs (including shipping and handling costs) associated with the distribution of finished product to our customers as cost of products sold, which were previously recorded in selling, general and administrative expenses (“SG&A”). We made this voluntary change in accounting policy because we believe this presentation is preferable, as the classification in cost of products sold better reflects the cost of producing and distributing products. Additionally, this presentation enhances the comparability of our financial statements with industry peers and aligns with how we now internally manage and review costs. As required by U.S. GAAP, the change has been reflected in the condensed consolidated statements of income through retrospective application of the change in accounting policy. The impact of this change resulted in an increase in cost of products sold and a decrease in SG&A of $148 million for the three months and $299 million for the six months ended June 28, 2015. |
• | We made a voluntary change in accounting policy to classify our trademark and license intangible asset impairments and amortization in SG&A, which were previously recorded in cost of products sold. We made this voluntary change in accounting policy because we believe this presentation is preferable, as removing these expenses from cost of products sold better aligns cost of products sold with costs directly associated with generating revenue. Additionally, this presentation enhances the comparability of our financial statements with industry peers and aligns with how we now internally manage and review costs. As required by U.S. GAAP, the change has been reflected in the condensed consolidated statements of income through retrospective application of the change in accounting policy. The impact of this change was an increase in SG&A and a decrease in cost of products sold by $63 million for the three months and $68 million for the six months ended June 28, 2015. |
• | We determined that we had previously misclassified customer related intangible asset amortization. Such costs were previously included in cost of products sold but should have been included in SG&A. We have revised the classification to report these expenses in SG&A in the condensed consolidated statements of income for the applicable prior periods presented. The impact of this revision was to increase SG&A and decrease cost of products sold by $16 million for the three months and $32 million for the six months ended June 28, 2015. This misstatement was not material to any prior period financial statements. |
Consistent with our consolidated financial statements in our Annual Report on Form 10-K for the year ended January 3, 2016, we separately presented sold receivables on our consolidated balance sheets and consolidated statements of cash flows. Our prior period cash flow balances have been reclassified to conform with the current period presentation.
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Recently Issued Accounting Standards:
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update (“ASU”) that superseded previously existing revenue recognition guidance. Under this ASU, companies will apply a principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the company expects to be entitled in exchange for those goods or services. This ASU will be effective beginning in the first quarter of our fiscal year 2018. The ASU may be applied retrospectively to historical periods presented or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.
In September 2015, the FASB issued an ASU intended to simplify the accounting for measurement period adjustments in a business combination. Measurement period adjustments are changes to provisional amounts recorded when the accounting for a business combination is incomplete as of the end of a reporting period. The measurement period can extend for up to a year following the transaction date. During the measurement period, companies may make adjustments to provisional amounts when information necessary to complete the measurement is received. The ASU requires companies to recognize these adjustments, including any related impacts to net income, in the reporting period in which the adjustments are determined. Companies are no longer required to retroactively apply measurement period adjustments to all periods presented. We early adopted this ASU in 2015. See Note 2, Merger and Acquisition, for additional information on measurement period adjustments.
In February 2016, the FASB issued an ASU that superseded previously existing leasing guidance. The ASU is intended to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The new guidance requires lessees to reflect most leases on their balance sheet as assets and obligations. This ASU will be effective beginning in the first quarter of our fiscal year 2019. Early adoption is permitted. The new guidance must be adopted using a modified retrospective transition, and provides for certain practical expedients. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.
In March 2016, the FASB issued an ASU intended to simplify equity-based award accounting and presentation. The ASU impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. This ASU will be effective beginning in the first quarter of our fiscal year 2017. Early adoption is permitted. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.
Note 2. Merger and Acquisition
Transaction Overview:
The 2015 Merger was accounted for under the acquisition method of accounting for business combinations and Heinz was considered to be the acquiring company. Under the acquisition method of accounting, total consideration exchanged was (in millions):
Aggregate fair value of Kraft common stock | $ | 42,502 | |
$16.50 per share special cash dividend | 9,782 | ||
Fair value of replacement equity awards | 353 | ||
Total consideration exchanged | $ | 52,637 |
Valuation Assumptions and Purchase Price Allocation:
We utilized estimated fair values at the 2015 Merger Date to allocate the total consideration exchanged to the net tangible and intangible assets acquired and liabilities assumed. Such allocation was final as of the issuance date of this report.
During the first half of 2016, we made measurement period adjustments to the preliminary purchase price allocation primarily reflecting (i) a decrease in indefinite-lived intangible assets of $2.0 billion, (ii) a decrease in deferred income tax liabilities of $564 million, and (iii) an increase in goodwill of $1.4 billion. We made these measurement period adjustments to reflect facts and circumstances that existed as of the 2015 Merger Date and did not result from intervening events subsequent to such date.
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The final purchase price allocation to assets acquired and liabilities assumed in the transaction was (in millions):
Cash | $ | 314 | |
Other current assets | 3,423 | ||
Property, plant and equipment | 4,179 | ||
Identifiable intangible assets | 47,771 | ||
Other non-current assets | 214 | ||
Trade and other payables | (3,026 | ) | |
Long-term debt | (9,286 | ) | |
Net postemployment benefits and other non-current liabilities | (4,739 | ) | |
Deferred income tax liabilities | (16,675 | ) | |
Net assets acquired | 22,175 | ||
Goodwill on acquisition | 30,462 | ||
Total consideration | 52,637 | ||
Fair value of shares exchanged and equity awards | 42,855 | ||
Total cash consideration paid to Kraft shareholders | 9,782 | ||
Cash and cash equivalents of Kraft at the 2015 Merger Date | 314 | ||
Acquisition of business, net of cash on hand | $ | 9,468 |
The 2015 Merger resulted in $30.5 billion of non tax deductible goodwill relating principally to synergies expected to be achieved from the combined operations and planned growth in new markets. Goodwill has been allocated to our segments as shown in Note 5, Goodwill and Intangible Assets.
Pro Forma Results:
The following table provides unaudited pro forma results, prepared in accordance with ASC 805, for the three and six months ended June 28, 2015, as if Kraft had been acquired as of December 30, 2013.
For the Three Months Ended | For the Six Months Ended | ||||||
June 28, 2015 | June 28, 2015 | ||||||
(in millions, except per share data) | |||||||
Net sales | $ | 7,130 | $ | 13,960 | |||
Net income | 366 | 1,104 | |||||
Basic earnings per share | 0.16 | 0.63 | |||||
Diluted earnings per share | 0.15 | 0.61 |
The unaudited pro forma results include certain purchase accounting adjustments. We have made pro forma adjustments to exclude deal costs (“Deal Costs”) of $47 million ($29 million net of tax) for the three months and $71 million ($44 million net of tax) for the six months ended June 28, 2015, because such costs are non-recurring and are directly attributable to the 2015 Merger. These expenses were included in the prior year pro forma results.
The unaudited pro forma results do not include any anticipated cost savings or other effects of future integration efforts. Unaudited pro forma amounts are not necessarily indicative of results had the 2015 Merger occurred on December 30, 2013 or of future results.
Note 3. Integration and Restructuring Expenses
Following the 2015 Merger, we announced a multi-year program (the “Integration Program”) designed to reduce costs, as well as integrate and optimize the combined organization. As part of these activities, we incur expenses (primarily employee separations, lease terminations and other direct exit costs) that qualify as exit and disposal costs under U.S. GAAP. We also incur expenses that are an integral component of, and directly attributable to, our restructuring activities, which do not qualify as exit and disposal costs (primarily accelerated depreciation, asset impairments, implementation costs such as new facility relocation and start-up costs, and other incremental costs).
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Employee severance and other termination benefit packages are primarily determined based on established benefit arrangements, local statutory requirements, or historical benefit practices. We recognize the contractual component of these benefits when payment is probable and estimable; additional elements of severance and termination benefits associated with non-recurring benefits are recognized ratably over each employee’s required future service period. Asset-related costs consist primarily of accelerated depreciation, and to a lesser degree asset impairments. Charges for accelerated depreciation are recognized on long-lived assets that will be taken out of service before the end of their normal service, in which case depreciation estimates are revised to reflect the use of the asset over its shortened useful life. Asset impairments establish a new fair value basis for assets held for disposal or sale and those assets are written down to expected net realizable value if carrying value exceeds fair value. All other costs are recognized as incurred.
Integration Program:
We currently expect the Integration Program will result in $1.9 billion of pre-tax costs, with approximately 60% reflected in cost of products sold, comprised of the following categories:
• | Organization costs ($650 million) associated with our plans to streamline and simplify our operating structure, resulting in workforce reduction. These costs primarily include: severance and employee benefits (cash severance, non-cash severance, including accelerated equity award compensation expense, and pension and other termination benefits). Beginning in August 2015, we announced a new, streamlined structure for our businesses in the United States and Canada segments. This resulted in the reduction of salaried positions across the United States and Canada. Overall, we expect to eliminate 2,950 positions in connection with this reduction. |
• | Footprint costs ($1.1 billion) associated with our plans to optimize our production and supply chain network, resulting in facility closures and consolidations. These costs primarily include: asset-related costs (accelerated depreciation and asset impairment charges), costs to exit facilities, relocation and start-up costs of new facilities, and severance and employee benefits. On November 4, 2015, we announced the closure of seven factories and began consolidation of our distribution network. In a staged process, production in these locations is shifting to other existing factories in the United States and Canada. Overall, we expect to eliminate 2,600 positions in connection with these activities. |
• | Other costs ($150 million) incurred as a direct result of integration activities, primarily including: contract and lease terminations, professional fees, and other incremental third-party fees. |
As of July 3, 2016, we have incurred $1.3 billion of cumulative costs under the Integration Program, including: $620 million of severance and employee benefit costs, $441 million of non-cash asset-related costs, $188 million of other implementation costs, and $80 million of other exit costs. We expect that approximately 60% of the Integration Program expenses will be cash expenditures. Our Integration Program costs during the three and six months ended July 3, 2016 were (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||
July 3, 2016 | July 3, 2016 | ||||||
Severance and employee benefit costs | $ | 30 | $ | 58 | |||
Asset-related costs | 149 | 305 | |||||
Other exit costs | 17 | 25 | |||||
Other implementation costs | 63 | 112 | |||||
$ | 259 | $ | 500 |
At July 3, 2016, the total Integration Program liability related primarily to the elimination of general salaried and footprint-related positions across the United States and Canada, 2,900 of whom have left the company by July 3, 2016. The liability balance associated with the Integration Program, which qualifies as U.S. GAAP exit and disposal costs, was (in millions):
Severance and Employee Benefit Costs | Other Exit Costs(a) | Total | |||||||||
Balance at January 3, 2016 | $ | 185 | $ | 23 | $ | 208 | |||||
Charges | 58 | 25 | 83 | ||||||||
Cash payments | (83 | ) | (38 | ) | (121 | ) | |||||
Non-cash utilization | (9 | ) | — | (9 | ) | ||||||
Balance at July 3, 2016 | $ | 151 | $ | 10 | $ | 161 |
(a) Other exit costs primarily represent contract and lease terminations.
We expect that a substantial portion of the July 3, 2016 Integration Program liability will be paid in 2016.
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Restructuring Activities:
Prior to the 2015 Merger, we executed a number of other restructuring activities focused primarily on workforce reduction and factory closure and consolidation, which are substantially complete. These programs, and other programs, resulted in the elimination of 8,250 positions and cumulative $568 million severance and employee benefit costs, $337 million non-cash asset-related costs, and $376 million other exit costs through July 3, 2016. Related to these restructuring activities, we incurred expenses of $25 million for the three months and $44 million for the six months ended July 3, 2016.
As of July 3, 2016, the liability balance associated with active restructuring projects, which qualifies as U.S. GAAP exit and disposal costs, was (in millions):
Severance and Employee Benefit Costs | Other Exit Costs(a) | Total | |||||||||
Balance at January 3, 2016 | $ | 25 | $ | 30 | $ | 55 | |||||
Charges | 17 | 1 | 18 | ||||||||
Cash payments | (25 | ) | (3 | ) | (28 | ) | |||||
Balance at July 3, 2016 | $ | 17 | $ | 28 | $ | 45 |
(a) Other exit costs primarily represent contract and lease terminations.
Total Integration and Restructuring:
Our total Integration Program and restructuring expenses were (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
Severance and employee benefit costs - COGS | $ | 23 | $ | 9 | $ | 29 | $ | 19 | |||||||
Severance and employee benefit costs - SG&A | 14 | 11 | 46 | 13 | |||||||||||
Asset-related costs - COGS | 137 | 31 | 279 | 34 | |||||||||||
Asset-related costs - SG&A | 12 | — | 26 | — | |||||||||||
Other exit costs - COGS | 39 | 6 | 72 | 23 | |||||||||||
Other exit costs - SG&A | 59 | 5 | 92 | 16 | |||||||||||
$ | 284 | $ | 62 | $ | 544 | $ | 105 |
We do not include Integration Program and restructuring expenses within Segment Adjusted EBITDA. See Note 14, Segment Reporting, for additional information on our segment structure. The pre-tax impact of allocating such expenses to our segments would have been (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
United States | $ | 247 | $ | 31 | $ | 446 | $ | 40 | |||||||
Canada | 9 | 11 | 27 | 12 | |||||||||||
Europe | 13 | 9 | 28 | 34 | |||||||||||
Rest of World | — | 5 | — | 9 | |||||||||||
Non-Operating | 15 | 6 | 43 | 10 | |||||||||||
$ | 284 | $ | 62 | $ | 544 | $ | 105 |
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Note 4. Inventories
Inventories at July 3, 2016 and January 3, 2016 were (in millions):
July 3, 2016 | January 3, 2016 | ||||||
Packaging and ingredients | $ | 601 | $ | 563 | |||
Work in process | 369 | 393 | |||||
Finished product | 1,911 | 1,662 | |||||
Inventories | $ | 2,881 | $ | 2,618 |
The increase in inventories in the second quarter of 2016 is primarily due to an increase in inventory production ahead of planned facility closures and consolidations under our Integration Program, combined with the impact of seasonality. See Note 3, Integration and Restructuring Expenses, for additional information on the Integration Program.
Note 5. Goodwill and Intangible Assets
Goodwill:
Changes in the carrying amount of goodwill from January 3, 2016 to July 3, 2016, by segment, were (in millions):
United States | Canada | Europe | Rest of World | Total | |||||||||||||||
Balance at January 3, 2016 | $ | 32,290 | $ | 4,796 | $ | 3,182 | $ | 2,783 | $ | 43,051 | |||||||||
2015 Merger measurement period adjustments | 1,433 | — | — | — | 1,433 | ||||||||||||||
Translation adjustments | — | 334 | (263 | ) | 86 | 157 | |||||||||||||
Balance at July 3, 2016 | $ | 33,723 | $ | 5,130 | $ | 2,919 | $ | 2,869 | $ | 44,641 |
In connection with the 2015 Merger, we recorded $30.5 billion of goodwill in purchase accounting, representing the fair value as of the 2015 Merger Date. As of the issuance date of this report, the assignment of goodwill to reporting units was final. During the first half of 2016, we made measurement period adjustments to the 2015 Merger purchase price allocation, resulting in an increase of $1.4 billion to goodwill in the United States segment. See Note 2, Merger and Acquisition, for additional information on these measurement period adjustments.
In the first quarter of 2016, we moved certain of our export businesses and their related goodwill balances from our United States segment to our Rest of World and Europe segments. We have reflected this change in all historical periods presented. Accordingly, the segment goodwill balances at January 3, 2016 reflect a decrease of $1,473 million in the United States, an increase of $1,443 million in Rest of World, and an increase of $30 million in Europe. These amounts represent the final allocation of goodwill associated with these export businesses.
We test goodwill for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2016 annual impairment testing in the second quarter of 2016. There was no impairment of goodwill as a result of our testing; however we noted that one reporting unit within the Rest of World segment had an estimated fair value in excess of its carrying value of less than 10%. The goodwill carrying value of this reporting unit was $48 million as of April 4, 2016 (our goodwill impairment testing date).
Our goodwill balance consists of a large number of individual reporting units and had an aggregate carrying value of $44.6 billion as of July 3, 2016. A significant portion of this goodwill was recorded in connection with the 2015 Merger, at which time it represented the estimated fair value. Because the 2015 Merger occurred recently, we have a risk of future impairment to the extent that individual goodwill reporting unit performance does not meet our projections. Additionally, if our current assumptions and estimates, including projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors, are not met, or if valuation factors outside of our control change unfavorably, the estimated fair value of our goodwill could be adversely affected, leading to a potential impairment in the future. There were no accumulated impairment losses to goodwill as of July 3, 2016.
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Indefinite-lived intangible assets:
In connection with the 2015 Merger, we recorded $43.1 billion of indefinite-lived intangible assets in purchase accounting, representing the fair values as of the 2015 Merger Date.
Indefinite-lived intangible assets, which primarily consisted of trademarks, were (in millions):
Balance at January 3, 2016 | $ | 55,824 | |
2015 Merger measurement period adjustments | (1,978 | ) | |
Translation adjustments | (253 | ) | |
Balance at July 3, 2016 | $ | 53,593 |
We test indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2016 annual impairment testing in the second quarter of 2016. There was no impairment of indefinite-lived intangibles as a result of our testing; however, we noted that seven brands each had excess fair values over their carrying values of less than 10%. These brands had an aggregate carrying value of $6.1 billion at April 4, 2016 (our indefinite-lived intangible asset impairment testing date). Of the $6.1 billion aggregate carrying value, $5.6 billion was attributable to Velveeta, Lunchables, Maxwell House, and Cracker Barrel.
Our indefinite-lived intangible assets primarily consist of a large number of individual brands and had an aggregate carrying value of $53.6 billion as of July 3, 2016. A significant portion of these brands were adjusted to their estimated fair values in connection with the 2015 Merger. Because the 2015 Merger occurred recently, we have a risk of future impairment to the extent individual brand performance does not meet our projections. Additionally, if our current assumptions and estimates, including projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors, are not met, or if valuation factors outside of our control change unfavorably, the estimated fair values of our indefinite-lived intangible assets could be adversely affected, leading to potential impairments in the future.
Definite-lived intangible assets:
Definite-lived intangible assets at July 3, 2016 and January 3, 2016 were (in millions):
July 3, 2016 | January 3, 2016 | ||||||||||||||||||||||
Gross | Accumulated Amortization | Net | Gross | Accumulated Amortization | Net | ||||||||||||||||||
Trademarks | $ | 2,354 | $ | (122 | ) | $ | 2,232 | $ | 2,346 | $ | (70 | ) | $ | 2,276 | |||||||||
Customer-related assets | 4,219 | (292 | ) | 3,927 | 4,218 | (209 | ) | 4,009 | |||||||||||||||
Other | 14 | (4 | ) | 10 | 15 | (4 | ) | 11 | |||||||||||||||
$ | 6,587 | $ | (418 | ) | $ | 6,169 | $ | 6,579 | $ | (283 | ) | $ | 6,296 |
Amortization expense for definite-lived intangible assets was $66 million for the three months and $132 million for the six months ended July 3, 2016 and was $22 million for the three months and $44 million for the six months ended June 28, 2015. Aside from amortization expense, the changes in definite-lived intangible assets from January 3, 2016 to July 3, 2016 reflect the impact of foreign currency. We estimate that annual amortization expense for definite-lived intangible assets for each of the next five years will be approximately $275 million.
Note 6. Income Taxes
The provision for income taxes consists of provisions for federal, state, and foreign income taxes. We operate in an international environment; accordingly, the consolidated income tax rate is a composite rate reflecting the earnings and applicable tax rates in various locations.
The effective tax rate was an expense of 30.1% for the three months and 29.7% for the six months ended July 3, 2016, reflecting the favorable benefit of pre-tax income in non-U.S. jurisdictions and certain tax exempt income. Our effective tax rate increased in comparison to the benefit of 17.6% for the three months and an expense of 21.8% for the six months ended June 28, 2015. The increase in our effective tax rate for the three and six months ended July 3, 2016 compared to the three and six months ended June 28, 2015 was driven by the 2015 Merger. With the 2015 Merger, our operations in the United States and Canada increased, resulting in an unfavorable impact to the effective tax rate of higher blended statutory tax rates and a favorable impact to the effective tax rate of a larger amount of tax exempt income.
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Note 7. Employees’ Stock Incentive Plans
Our annual equity award grants and vesting occurred in the first quarter of 2016. Other off-cycle equity grants may occur throughout the year.
Stock Options:
Our stock option activity and related information was:
Number of Stock Options | Weighted Average Exercise Price (per share) | |||||
Outstanding at January 3, 2016 | 24,205,612 | $ | 34.86 | |||
Options granted | 1,204,005 | 77.66 | ||||
Options forfeited | (470,020 | ) | 40.65 | |||
Options exercised | (3,090,965 | ) | 35.04 | |||
Outstanding at July 3, 2016 | 21,848,632 | 37.07 |
The aggregate intrinsic value of stock options exercised during the period was $137 million for the six months ended July 3, 2016.
Restricted Stock Units:
Our restricted stock unit (“RSU”) activity and related information was:
Number of Units | Weighted Average Grant Date Fair Value (per share) | |||||
RSUs at January 3, 2016 | 968,444 | $ | 70.14 | |||
Granted | 499,563 | 77.49 | ||||
Forfeited | (57,558 | ) | 73.83 | |||
Vested | (404,578 | ) | 72.96 | |||
RSUs at July 3, 2016 | 1,005,871 | 72.43 |
The aggregate fair value of RSUs that vested during the period was $30 million for the six months ended July 3, 2016.
Total Equity Awards:
The compensation cost related to equity awards was primarily recognized in general corporate expenses within SG&A. Equity award compensation cost and the related tax benefit was (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
Pre-tax compensation cost | $ | 13 | $ | 3 | $ | 26 | $ | 5 | |||||||
Tax benefit | (4 | ) | (1 | ) | (8 | ) | (2 | ) | |||||||
After-tax compensation cost | $ | 9 | $ | 2 | $ | 18 | $ | 3 |
Unrecognized compensation cost related to unvested equity awards was $114 million at July 3, 2016 and is expected to be recognized over a weighted average period of three years.
Note 8. Postemployment Benefits
In the first quarter of 2016, we changed the method that we use to estimate the service cost and interest cost components of net pension cost/(benefit) and net postretirement cost/(benefit). We use a full yield curve approach to estimate service cost and interest cost by applying the specific spot rates along the yield curve used to determine the benefit obligation to the relevant projected cash flows. Previously, we estimated service cost and interest cost using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. We made this change to provide a more precise measurement of service cost and interest cost by improving the correlation between projected benefit cash flows and the corresponding spot yield curve rates. The change resulted in a decrease in service and interest cost of approximately $20 million in the three months ended July 3, 2016 and approximately $40 million in the six months ended July 3, 2016 compared to what our costs would have been under the previous method. This change did not affect the measurement of our total benefit obligations. We have accounted for this change prospectively as a change in accounting estimate.
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Pension Plans
Components of Net Pension Cost/(Benefit):
Net pension cost/(benefit) consisted of the following for the three and six months ended July 3, 2016 and June 28, 2015 (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||||||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | ||||||||||||||||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||||||||||||||
Service cost | $ | 4 | $ | 2 | $ | 6 | $ | 5 | $ | 7 | $ | 3 | $ | 12 | $ | 10 | |||||||||||||||
Interest cost | 53 | 4 | 22 | 22 | 106 | 9 | 43 | 43 | |||||||||||||||||||||||
Expected return on plan assets | (74 | ) | (3 | ) | (47 | ) | (42 | ) | (148 | ) | (8 | ) | (93 | ) | (85 | ) | |||||||||||||||
Amortization of unrecognized losses/(gains) | — | 1 | — | — | — | 2 | — | — | |||||||||||||||||||||||
Settlements | — | — | — | 11 | (6 | ) | — | — | 11 | ||||||||||||||||||||||
Curtailments | — | — | — | (2 | ) | — | — | — | (2 | ) | |||||||||||||||||||||
Net pension cost/(benefit) | $ | (17 | ) | $ | 4 | $ | (19 | ) | $ | (6 | ) | $ | (41 | ) | $ | 6 | $ | (38 | ) | $ | (23 | ) |
We capitalized a portion of net pension costs/(benefits) into inventory based on our production activities. These amounts are included in the table above.
Employer Contributions:
During the six months ended July 3, 2016, we contributed $161 million to our U.S. pension plans, which included contributions related to the settlement of our U.S. nonqualified pension plan that was terminated effective December 31, 2015. During the six months ended July 3, 2016, we contributed $16 million to our non-U.S. pension plans. Based on our contribution strategy, we plan to make further contributions of up to approximately $150 million to our U.S. plans and approximately $15 million to our non-U.S. plans during the remainder of 2016. However, our actual contributions may differ due to many factors, including changes in tax, employee benefit or other laws, tax deductibility, significant differences between expected and actual pension asset performance or interest rates, or other factors.
Postretirement Plans
Components of Net Postretirement Cost/(Benefit):
Net postretirement cost/(benefit) consisted of the following for the three and six months ended July 3, 2016 and June 28, 2015 (in millions):
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
Service cost | $ | 4 | $ | 1 | $ | 8 | $ | 2 | |||||||
Interest cost | 14 | 2 | 30 | 4 | |||||||||||
Amortization of prior service costs/(credits) | (80 | ) | (2 | ) | (162 | ) | (3 | ) | |||||||
Net postretirement cost /(benefit) | $ | (62 | ) | $ | 1 | $ | (124 | ) | $ | 3 |
We capitalized a portion of net postretirement costs/(benefits) into inventory based on our production activities. These amounts are included in the table above.
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Note 9. Accumulated Other Comprehensive Income/(Losses)
The components of, and changes in, accumulated other comprehensive income/(losses) were as follows (net of tax):
Foreign Currency Translation Adjustments | Net Postemployment Benefit Plan Adjustments | Net Cash Flow Hedge Adjustments | Total | ||||||||||||
(in millions) | |||||||||||||||
Balance as of January 3, 2016 | $ | (1,646 | ) | $ | 922 | $ | 53 | $ | (671 | ) | |||||
Foreign currency translation adjustments | (153 | ) | — | — | (153 | ) | |||||||||
Net deferred gains/(losses) on net investment hedges | 45 | — | — | 45 | |||||||||||
Reclassification of net postemployment benefit losses/(gains) | — | (104 | ) | — | (104 | ) | |||||||||
Net deferred gains/(losses) on cash flow hedges | — | — | (32 | ) | (32 | ) | |||||||||
Net deferred losses/(gains) on cash flow hedges reclassified to net income | — | — | (18 | ) | (18 | ) | |||||||||
Total other comprehensive income/(loss) | (108 | ) | (104 | ) | (50 | ) | (262 | ) | |||||||
Balance as of July 3, 2016 | $ | (1,754 | ) | $ | 818 | $ | 3 | $ | (933 | ) |
Reclassification of net postemployment benefit losses/(gains) included amounts reclassified to net income and amounts reclassified into inventory (consistent with our capitalization policy).
The gross amount and related tax benefit/(expense) recorded in, and associated with, each component of other comprehensive income/(loss) for the three and six months ended July 3, 2016 and June 28, 2015 were as follows (in millions):
For the Three Months Ended | |||||||||||||||||||||||
July 3, 2016 | June 28, 2015 | ||||||||||||||||||||||
Before Tax Amount | Tax | Net of Tax Amount | Before Tax Amount | Tax | Net of Tax Amount | ||||||||||||||||||
Foreign currency translation adjustments | $ | (418 | ) | $ | — | $ | (418 | ) | $ | 360 | $ | — | $ | 360 | |||||||||
Net deferred gains/(losses) on net investment hedges | 194 | (89 | ) | 105 | (330 | ) | 124 | (206 | ) | ||||||||||||||
Net actuarial gains/(losses) arising during the period | — | — | — | (23 | ) | 5 | (18 | ) | |||||||||||||||
Reclassification of net postemployment benefit losses/(gains) | (80 | ) | 30 | (50 | ) | 10 | (2 | ) | 8 | ||||||||||||||
Net deferred gains/(losses) on cash flow hedges | (17 | ) | 3 | (14 | ) | (8 | ) | (2 | ) | (10 | ) | ||||||||||||
Net deferred losses/(gains) on cash flow hedges reclassified to net income | 6 | (2 | ) | 4 | 223 | (86 | ) | 137 |
For the Six Months Ended | |||||||||||||||||||||||
July 3, 2016 | June 28, 2015 | ||||||||||||||||||||||
Before Tax Amount | Tax | Net of Tax Amount | Before Tax Amount | Tax | Net of Tax Amount | ||||||||||||||||||
Foreign currency translation adjustments | $ | (153 | ) | $ | — | $ | (153 | ) | $ | (420 | ) | $ | — | $ | (420 | ) | |||||||
Net deferred gains/(losses) on net investment hedges | 110 | (65 | ) | 45 | 421 | (195 | ) | 226 | |||||||||||||||
Net actuarial gains/(losses) arising during the period | — | — | — | (25 | ) | 6 | (19 | ) | |||||||||||||||
Reclassification of net postemployment benefit losses/(gains) | (168 | ) | 64 | (104 | ) | 10 | (3 | ) | 7 | ||||||||||||||
Net deferred gains/(losses) on cash flow hedges | (45 | ) | 13 | (32 | ) | (120 | ) | 43 | (77 | ) | |||||||||||||
Net deferred losses/(gains) on cash flow hedges reclassified to net income | (20 | ) | 2 | (18 | ) | 222 | (84 | ) | 138 |
15
The amounts reclassified from accumulated other comprehensive income/(losses) in the three and six months ended July 3, 2016 and June 28, 2015 were as follows (in millions):
Accumulated Other Comprehensive Income/(Losses) Component | Reclassified from Accumulated Other Comprehensive Income/(Losses) | Affected Line Item in the Statement Where Net Income is Presented | ||||||||||||||||
For the Three Months Ended | For the Six Months Ended | |||||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | |||||||||||||||
Losses/(gains) on cash flow hedges: | ||||||||||||||||||
Foreign exchange contracts | $ | (2 | ) | $ | 1 | $ | (3 | ) | $ | 2 | Net sales | |||||||
Foreign exchange contracts | (4 | ) | (11 | ) | (33 | ) | (16 | ) | Cost of products sold | |||||||||
Foreign exchange contracts | 11 | — | 14 | (1 | ) | Other expense/(income), net | ||||||||||||
Interest rate contracts | 1 | 233 | 2 | 237 | Interest expense | |||||||||||||
Losses/(gains) on cash flow hedges before income taxes | 6 | 223 | (20 | ) | 222 | |||||||||||||
Losses/(gains) on cash flow hedges income taxes | (2 | ) | (86 | ) | 2 | (84 | ) | |||||||||||
Losses/(gains) on cash flow hedges | $ | 4 | $ | 137 | $ | (18 | ) | $ | 138 | |||||||||
Losses/(gains) on postemployment benefits: | ||||||||||||||||||
Amortization of unrecognized losses/(gains) | $ | — | $ | 1 | $ | — | $ | 2 | (a) | |||||||||
Amortization of prior service costs/(credits) | (80 | ) | (2 | ) | (162 | ) | (3 | ) | (a) | |||||||||
Settlement and curtailments losses/(gains) | — | 11 | (6 | ) | 11 | (a) | ||||||||||||
Losses/(gains) on postemployment benefits before income taxes | (80 | ) | 10 | (168 | ) | 10 | ||||||||||||
Losses/(gains) on postemployment benefits income taxes | 30 | (2 | ) | 64 | (3 | ) | ||||||||||||
Losses/(gains) on postemployment benefits | $ | (50 | ) | $ | 8 | $ | (104 | ) | $ | 7 |
(a) | These components are included in the computation of net periodic postemployment benefit costs. See Note 8, Postemployment Benefits, for additional information. |
In this note we have excluded activity and balances related to noncontrolling interest (which was primarily comprised of foreign currency translation adjustments) due to its insignificance.
Note 10. Financial Instruments
See our consolidated financial statements and related notes in our Annual Report on Form 10-K for the year ended January 3, 2016 for additional information on our overall risk management strategies, our use of derivatives, and our related accounting policies.
Derivative Volume:
The notional values of our derivative instruments at July 3, 2016 and January 3, 2016 were (in millions):
Notional Amount | |||||||
July 3, 2016 | January 3, 2016 | ||||||
Commodity contracts | $ | 474 | $ | 787 | |||
Foreign exchange contracts | 2,820 | 3,458 | |||||
Cross-currency contracts | 3,173 | 4,328 |
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Fair Value of Derivative Instruments:
The fair values and the levels within the fair value hierarchy of derivative instruments recorded on the condensed consolidated balance sheets at July 3, 2016 and January 3, 2016 were (in millions):
July 3, 2016 | |||||||||||||||||||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||||||||||
Assets | Liabilities | Assets | Liabilities | Assets | Liabilities | Assets | Liabilities | ||||||||||||||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||||||||||||||||
Foreign exchange contracts | $ | — | $ | — | $ | 27 | $ | 41 | $ | — | $ | — | $ | 27 | $ | 41 | |||||||||||||||
Cross-currency contracts | — | — | 450 | 14 | — | — | 450 | 14 | |||||||||||||||||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||||||||||||||||
Commodity contracts | 39 | 6 | 1 | 3 | — | — | 40 | 9 | |||||||||||||||||||||||
Foreign exchange contracts | — | — | 27 | 15 | — | — | 27 | 15 | |||||||||||||||||||||||
Cross-currency contracts | — | — | 40 | — | — | — | 40 | — | |||||||||||||||||||||||
Total fair value | $ | 39 | $ | 6 | $ | 545 | $ | 73 | $ | — | $ | — | $ | 584 | $ | 79 |
January 3, 2016 | |||||||||||||||||||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||||||||||
Assets | Liabilities | Assets | Liabilities | Assets | Liabilities | Assets | Liabilities | ||||||||||||||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||||||||||||||||
Foreign exchange contracts | $ | — | $ | — | $ | 46 | $ | 6 | $ | — | $ | — | $ | 46 | $ | 6 | |||||||||||||||
Cross-currency contracts | — | — | 605 | — | — | — | 605 | — | |||||||||||||||||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||||||||||||||||
Commodity contracts | 24 | 29 | 1 | 7 | — | — | 25 | 36 | |||||||||||||||||||||||
Foreign exchange contracts | — | — | 88 | 13 | — | — | 88 | 13 | |||||||||||||||||||||||
Cross-currency contracts | — | — | 47 | — | — | — | 47 | — | |||||||||||||||||||||||
Total fair value | $ | 24 | $ | 29 | $ | 787 | $ | 26 | $ | — | $ | — | $ | 811 | $ | 55 |
Our derivative financial instruments are subject to master netting arrangements that allow for the offset of assets and liabilities in the event of default or early termination of the contract. We elect to record the gross assets and liabilities of our derivative financial instruments on the condensed consolidated balance sheets. If the derivative financial instruments had been netted on the condensed consolidated balance sheets, the asset and liability positions each would have been reduced by $46 million at July 3, 2016 and $44 million at January 3, 2016. No material amounts of collateral were received or posted on our derivative assets and liabilities at July 3, 2016.
Level 1 financial assets and liabilities consist of commodity future and options contracts and are valued using quoted prices in active markets for identical assets and liabilities.
Level 2 financial assets and liabilities consist of commodity forwards, foreign exchange forwards, and cross-currency swaps. Commodity forwards are valued using an income approach based on the observable market commodity index prices less the contract rate multiplied by the notional amount. Foreign exchange forwards are valued using an income approach based on observable market forward rates less the contract rate multiplied by the notional amount. Cross-currency swaps are valued based on observable market spot and swap rates.
Our calculation of the fair value of financial instruments takes into consideration the risk of nonperformance, including counterparty credit risk.
There have been no transfers between Levels 1, 2, and 3 in any period presented.
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The fair values of our asset derivatives are recorded within other current assets and other assets. The fair values of our liability derivatives are recorded within other current liabilities and other liabilities.
Net Investment Hedging:
In the second quarter of 2016, we issued €1.8 billion aggregate principal amount of Euro denominated notes (see Note 12, Commitments, Contingencies and Debt). The principal amounts of this foreign denominated debt were designated as net investment hedges. Concurrently, we fully unwound our Euro swap (USD notional amount of $1.1 billion). At July 3, 2016, the principal amounts of foreign denominated debt designated as net investment hedges totaled €2,550 million and £400 million.
At July 3, 2016, our cross-currency swaps designated as net investment hedges consisted of:
Instrument | Notional (local) (in billions) | Notional (USD) (in billions) | Maturity | |||||||
Cross-currency swap | £ | 0.8 | $ | 1.4 | October 2019 | |||||
Cross-currency swap | C$ | 1.8 | 1.6 | December 2019 |
We also periodically enter into shorter-dated foreign currency contracts that are designated as net investment hedges. At July 3, 2016, we had Euro foreign currency contracts with aggregate USD notional amounts of $196 million and Canadian dollar foreign currency contracts with aggregate USD notional amounts of $51 million outstanding.
Hedge Coverage:
At July 3, 2016, we had entered into contracts designated as hedging instruments, which hedge transactions for the following durations:
• | foreign currency contracts for periods not exceeding the next two years, and |
• | cross-currency contracts for periods not exceeding the next four years. |
At July 3, 2016, we had entered into contracts not designated as hedging instruments, which hedge economic risks for the following durations:
• | commodity contracts for periods not exceeding the next 12 months, |
• | foreign exchange contracts for periods not exceeding the next 12 months, and |
• | cross-currency contracts for periods not exceeding the next three years. |
Hedge Ineffectiveness:
We record pre-tax gains or losses reclassified from accumulated other comprehensive income/(losses) due to ineffectiveness in:
• | other expense/(income), net for foreign exchange contracts related to forecasted transactions. |
Deferred Hedging Gains and Losses:
Based on our valuation at July 3, 2016 and assuming market rates remain constant through contract maturities, we expect transfers to net income/(loss) of unrealized gains for foreign currency cash flow hedges during the next 12 months to be insignificant. Additionally, we expect transfers to net income/(loss) of unrealized losses for interest rate cash flow hedges during the next 12 months to be insignificant.
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Derivative Impact on the Statements of Income and Statements of Comprehensive Income:
The following tables present the pre-tax effect of derivative instruments on the condensed consolidated statements of income and statements of comprehensive income for the three and six months ended July 3, 2016 and June 28, 2015 (in millions):
For the Three Months Ended | |||||||||||||||||||||||||||||||
July 3, 2016 | June 28, 2015 | ||||||||||||||||||||||||||||||
Commodity Contracts | Foreign Exchange Contracts | Cross-Currency Contracts | Interest Rate Contracts | Commodity Contracts | Foreign Exchange Contracts | Cross-Currency Contracts | Interest Rate Contracts | ||||||||||||||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||||||||||||||||
Cash flow hedges: | |||||||||||||||||||||||||||||||
Gains/(losses) recognized in other comprehensive income (effective portion) | $ | — | $ | (9 | ) | $ | — | $ | (8 | ) | $ | — | $ | (17 | ) | $ | — | $ | 9 | ||||||||||||
Net investment hedges: | |||||||||||||||||||||||||||||||
Gains/(losses) recognized in other comprehensive income (effective portion) | — | 46 | 90 | — | — | — | (330 | ) | — | ||||||||||||||||||||||
Total gains/(losses) recognized in other comprehensive income (effective portion) | $ | — | $ | 37 | $ | 90 | $ | (8 | ) | $ | — | $ | (17 | ) | $ | (330 | ) | $ | 9 | ||||||||||||
Cash flow hedges reclassified to net income/(loss): | |||||||||||||||||||||||||||||||
Net sales | $ | — | $ | 2 | $ | — | $ | — | $ | — | $ | (1 | ) | $ | — | $ | — | ||||||||||||||
Cost of products sold (effective portion) | — | 4 | — | — | — | 11 | — | — | |||||||||||||||||||||||
Other expense/(income), net | — | (11 | ) | — | — | — | — | — | — | ||||||||||||||||||||||
Interest expense | — | — | — | (1 | ) | — | — | — | (233 | ) | |||||||||||||||||||||
— | (5 | ) | — | (1 | ) | — | 10 | — | (233 | ) | |||||||||||||||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||||||||||||||||
Gains/(losses) on derivatives recognized in cost of products sold | 29 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Gains/(losses) on derivatives recognized in other expense/(income), net | — | 18 | (1 | ) | — | — | (16 | ) | — | — | |||||||||||||||||||||
29 | 18 | (1 | ) | — | — | (16 | ) | — | — | ||||||||||||||||||||||
Total gains/(losses) recognized in statements of income | $ | 29 | $ | 13 | $ | (1 | ) | $ | (1 | ) | $ | — | $ | (6 | ) | $ | — | $ | (233 | ) |
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For the Six Months Ended | |||||||||||||||||||||||||||||||
July 3, 2016 | June 28, 2015 | ||||||||||||||||||||||||||||||
Commodity Contracts | Foreign Exchange Contracts | Cross-Currency Contracts | Interest Rate Contracts | Commodity Contracts | Foreign Exchange Contracts | Cross-Currency Contracts | Interest Rate Contracts | ||||||||||||||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||||||||||||||||
Cash flow hedges: | |||||||||||||||||||||||||||||||
Gains/(losses) recognized in other comprehensive income (effective portion) | $ | — | $ | (37 | ) | $ | — | $ | (8 | ) | $ | — | $ | (9 | ) | $ | — | $ | (111 | ) | |||||||||||
Net investment hedges: | |||||||||||||||||||||||||||||||
Gains/(losses) recognized in other comprehensive income (effective portion) | — | 46 | 25 | — | — | — | 421 | — | |||||||||||||||||||||||
Total gains/(losses) recognized in other comprehensive income (effective portion) | $ | — | $ | 9 | $ | 25 | $ | (8 | ) | $ | — | $ | (9 | ) | $ | 421 | $ | (111 | ) | ||||||||||||
Cash flow hedges reclassified to net income/(loss): | |||||||||||||||||||||||||||||||
Net sales | $ | — | $ | 3 | $ | — | $ | — | $ | — | $ | (2 | ) | $ | — | $ | — | ||||||||||||||
Cost of products sold (effective portion) | — | 33 | — | — | — | 16 | — | — | |||||||||||||||||||||||
Other expense/(income), net | — | (14 | ) | — | — | — | 1 | — | — | ||||||||||||||||||||||
Interest expense | — | — | — | (2 | ) | — | — | — | (237 | ) | |||||||||||||||||||||
— | 22 | — | (2 | ) | — | 15 | — | (237 | ) | ||||||||||||||||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||||||||||||||||
Gains/(losses) on derivatives recognized in cost of products sold | 11 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Gains/(losses) on derivatives recognized in other expense/(income), net | — | (57 | ) | (8 | ) | — | — | 33 | — | 11 | |||||||||||||||||||||
11 | (57 | ) | (8 | ) | — | — | 33 | — | 11 | ||||||||||||||||||||||
Total gains/(losses) recognized in statements of income | $ | 11 | $ | (35 | ) | $ | (8 | ) | $ | (2 | ) | $ | — | $ | 48 | $ | — | $ | (226 | ) |
Related to our non-derivative, foreign denominated debt instruments designated as net investment hedges, we recognized a pre-tax gain in other comprehensive income/(loss) of $58 million for the three months and $39 million for the six months ended July 3, 2016.
Note 11. Venezuela - Foreign Currency and Inflation
In February 2016, the Venezuela government announced the following changes to its foreign currency exchange mechanisms, which were effective on March 10, 2016:
• | the official exchange rate of BsF6.30 per U.S. dollar, which was available through the government-operated National Center of Foreign Commerce (“CENCOEX”), was devalued to BsF10 per U.S. dollar; |
• | the CENCOEX was replaced with the Sistema de Divisa Protegida (“DIPRO”), which is available for purchases and sales of essential items, including food products; |
• | the Complimentary System of Foreign Currency Acquirement (“SICAD”) was eliminated; and |
• | the Marginal Currency System (“SIMADI”) was replaced with the Sistema de Divisa Complementaria (“DICOM”), which is available for all transactions not covered by DIPRO and is a free-floating exchange format. |
At July 3, 2016, there were two exchange rates legally available to us for converting Venezuelan bolivars to U.S. dollars, including:
• | the official exchange rate of BsF10 per U.S. dollar available through DIPRO; and |
• | the DICOM rate, which averaged BsF462 per U.S. dollar for the three months and BsF338 per U.S. dollar for the six months ended July 3, 2016, and was BsF628 per U.S. dollar at July 3, 2016. |
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In June 2015, due to the continued lack of liquidity and increasing economic uncertainty, we reevaluated the rate used to remeasure the monetary assets and liabilities of our Venezuelan subsidiary. As of June 28, 2015, we determined that the then current SIMADI rate of BsF197.7 per U.S. dollar was the most appropriate legally available rate and remeasured our net monetary assets of our Venezuelan subsidiary, resulting in a nonmonetary currency devaluation of $234 million recorded in other expense/(income), net, in the condensed consolidated statements of income for the three and six months ended June 28, 2015. Additionally, we assessed the nonmonetary assets of our Venezuelan subsidiary for impairment, which resulted in a $49 million loss to write down inventory to the lower of cost or market, which was recorded in cost of products sold in the condensed consolidated statements of income for the three and six months ended June 28, 2015. As of July 3, 2016, we continue to believe that the DICOM rate (formerly SIMADI) is the most appropriate legally available rate.
During the second quarter of 2016, the DICOM rate increased significantly to BsF628 per U.S. dollar as of July 3, 2016. We remeasured the net monetary assets and operating results of our Venezuelan subsidiary to reflect this increase, resulting in a nonmonetary currency devaluation of $7 million recorded in other expense/(income), net, in the condensed consolidated statements of income for the three and six months ended July 3, 2016. In addition, we assessed the nonmonetary assets of our Venezuelan subsidiary for impairment, resulting in a $53 million loss to write down property, plant and equipment, net, and prepaid spare parts, which was recorded within cost of products sold in the condensed consolidated statements of income for the three and six months ended July 3, 2016.
We have had limited access to, and settlements at, the official exchange rate of BsF6.30 per U.S. dollar and no settlements at the official exchange rate of BsF10 per U.S. dollar during the three and six months ended July 3, 2016. We had outstanding requests of $26 million at July 3, 2016 for payment of invoices for the purchase of ingredients and packaging materials for the years from 2012 through 2015, all of which were requested for payment at BsF6.30 per U.S. dollar.
Our results of operations in Venezuela reflect a controlled subsidiary. However, the continuing economic uncertainty, strict labor laws, and evolving government controls over imports, prices, currency exchange and payments present a challenging operating environment. Increased restrictions imposed by the Venezuelan government or further deterioration of the economic environment could impact our ability to control our Venezuelan operations and could lead us to deconsolidate our Venezuelan subsidiary in the future.
Note 12. Commitments, Contingencies and Debt
Legal Proceedings
We are routinely involved in legal proceedings, claims, and governmental inquiries, inspections or investigations (“Legal Matters”) arising in the ordinary course of our business.
On April 1, 2015, the Commodity Futures Trading Commission (“CFTC”) filed a formal complaint against Mondelēz International, Inc. (“Mondelēz International”) and Kraft in the U.S. District Court for the Northern District of Illinois, Eastern Division, related to activities involving the trading of December 2011 wheat futures contracts. The complaint alleges that Mondelēz International and Kraft (1) manipulated or attempted to manipulate the wheat markets during the fall of 2011, (2) violated position limit levels for wheat futures, and (3) engaged in non-competitive trades by trading both sides of exchange-for-physical Chicago Board of Trade wheat contracts. As previously disclosed by Kraft, these activities arose prior to the October 1, 2012 spin-off of Kraft by Mondelēz International to its shareholders and involve the business now owned and operated by Mondelēz International or its affiliates. The Separation and Distribution Agreement between Kraft and Mondelēz International, dated as of September 27, 2012, governs the allocation of liabilities between Mondelēz International and Kraft and, accordingly, Mondelēz International will predominantly bear the costs of this matter and any monetary penalties or other payments that the CFTC may impose. We do not expect this matter to have a material adverse effect on our financial condition, results of operations, or business.
While we cannot predict with certainty the results of Legal Matters in which we are currently involved or may in the future be involved, we do not expect that the ultimate costs to resolve any of the Legal Matters that are currently pending will have a material adverse effect on our financial condition or results of operations.
Debt
Borrowing Arrangements:
On May 4, 2016, together with Kraft Heinz Foods Company, our wholly owned operating subsidiary, we entered into the first amendment (the “First Amendment”) to the credit agreement dated as of July 6, 2015 (the “Credit Agreement”) described in our Annual Report on Form 10-K for the year ended January 3, 2016.
Among other things, the First Amendment (a) provided for a one time modification of the extension period of the Credit Agreement, (b) increased the letter of credit sublimit from $150 million to $300 million and (c) expanded the available currencies in which
21
revolving loans can be issued with the mutual consent of Kraft Heinz Foods Company and the applicable lender. In connection with the First Amendment, the maturity date of the revolving loans and commitments under the Credit Agreement was extended from July 6, 2020 to July 6, 2021.
The obligations under the Credit Agreement continue to be guaranteed by Kraft Heinz Foods Company in the case of indebtedness and other liabilities of any subsidiary borrower and by Kraft Heinz in the case of indebtedness and other liabilities of any subsidiary borrower and Kraft Heinz Foods Company. The Credit Agreement contains representations, warranties, covenants and events of default that are typical for this type of facility.
During the second quarter of 2016, we also commenced a commercial paper program. As of July 3, 2016, we had $633 million of commercial paper outstanding, which had a weighted average interest rate of 1.129%. There was no commercial paper outstanding at January 3, 2016.
Debt Issuance:
The carrying value of our long-term debt, including the current portion, was $32.1 billion at July 3, 2016 and $25.2 billion at January 3, 2016. The increase during the period was driven by new issuances of long-term debt in May 2016, as described below.
• | On May 24, 2016, we completed the sale of $2.0 billion aggregate principal amount of 3.000% Senior Notes due June 1, 2026 (the “2026 Notes”) and $3.0 billion aggregate principal amount of 4.375% Senior Notes due June 1, 2046 (the “2046 Notes” and, together with the 2026 Notes, the “U.S. Dollar Notes”). Interest on the U.S. Dollar Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on December 1, 2016. |
• | On May 25, 2016, we completed the sale of €550 million aggregate principal amount of 1.500% Senior Notes due May 24, 2024 (the “2024 Notes”) and €1,250 million aggregate principal amount of 2.250% Senior Notes due May 25, 2028 (the “2028 Notes” and, together with the 2024 Notes, the “Euro Notes”). Interest on the 2024 Notes is payable annually in arrears on May 24 of each year, beginning on May 24, 2017. Interest on the 2028 Notes is payable annually in arrears on May 25 of each year, beginning on May 25, 2017. |
We used the net proceeds from the U.S. Dollar Notes and Euro Notes issuances primarily to redeem all outstanding shares of our 9.00% cumulative compounding preferred stock, Series A (“Series A Preferred Stock”).
The U.S. Dollar Notes and the Euro Notes were issued by Kraft Heinz Foods Company and are fully and unconditionally guaranteed as to payment of principal, premium, if any, and interest on a senior unsecured basis by Kraft Heinz. The U.S. Dollar Notes and the Euro Notes contain customary covenants and events of default.
We incurred debt issuance costs related to the sale of the U.S. Dollar Notes and the Euro Notes of $52 million, which is reflected as a direct deduction of our long-term debt balance on the condensed consolidated balance sheets at July 3, 2016.
Fair Value of Debt:
At July 3, 2016, the aggregate fair value of our total debt was $35.6 billion. We determined the fair value of our short-term debt using Level 1 quoted prices in active markets. We determined the fair value of our long-term debt using Level 2 inputs. Fair values are generally estimated based on quoted market prices for identical or similar instruments.
Series A Preferred Stock
As noted above, on June 7, 2016, we redeemed all outstanding shares of our Series A Preferred Stock. We funded this redemption primarily through the issuance of the U.S. Dollar Notes and Euro Notes, as well as other sources of liquidity, including our commercial paper program, U.S. securitization program, and cash on hand. In connection with the redemption, all Series A Preferred Stock was canceled and automatically retired. Additionally, on June 7, 2016, we filed a Certificate of Retirement of Series A Preferred Stock, which reduced the number of our preferred shares authorized by 80,000 to 920,000 and eliminated all references to the Series A Preferred Stock from our Certificate of Incorporation.
Financing Arrangements
In May 2016, we amended our U.S. securitization program. Under the new terms, we receive cash consideration of up to $800 million and a receivable for the remainder of the purchase price (the “Deferred Purchase Price”). This program expires in May 2017. There were no significant changes to our other accounts receivable securitization and factoring programs (“Programs”) during the six months ended January 3, 2016. See Note 15, Financing Arrangements, to our consolidated financial statements for the year ended January 3, 2016 in our Annual Report on Form 10-K for additional information on the Programs.
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The cash consideration and carrying amount of receivables removed from the condensed consolidated balance sheets in connection with the Programs were $860 million at July 3, 2016 and $267 million at January 3, 2016. The fair value of the Deferred Purchase Price for the Programs was $146 million at July 3, 2016 and $583 million at January 3, 2016. The Deferred Purchase Price is included in sold receivables on the condensed consolidated balance sheets and had a carrying value which approximated its fair value at July 3, 2016 and January 3, 2016.
Redeemable Noncontrolling Interest
In April 2016, the minority partner in our Brazilian subsidiary, Coniexpress S.A. Industrias Alimenticias (“Coniexpress”), exercised a put option that required us to purchase its 5% equity interest in the subsidiary for $21 million. The redemption value was determined based on a specified formula within the shareholders' agreement between our Brazilian subsidiary and the minority partner. An adjustment was made to retained earnings to record the carrying value at the maximum redemption value immediately prior to this transaction. As this exercise did not result in a change in control of Coniexpress, it was accounted for as an equity transaction. We now own 100% of our Brazilian subsidiary.
Note 13. Earnings Per Share
Our earnings per common share (“EPS”) for the three and six months ended July 3, 2016 and June 28, 2015 were:
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
(in millions, except per share amounts) | |||||||||||||||
Basic Earnings Per Common Share: | |||||||||||||||
Net income/(loss) attributable to common shareholders | $ | 770 | $ | (344 | ) | $ | 1,666 | $ | (248 | ) | |||||
Weighted average shares of common stock outstanding | 1,217 | 380 | 1,216 | 379 | |||||||||||
Net earnings/(loss) | $ | 0.63 | $ | (0.91 | ) | $ | 1.37 | $ | (0.66 | ) | |||||
Diluted Earnings Per Common Share: | |||||||||||||||
Net income/(loss) attributable to common shareholders | $ | 770 | $ | (344 | ) | $ | 1,666 | $ | (248 | ) | |||||
Weighted average shares of common stock outstanding | 1,217 | 380 | 1,216 | 379 | |||||||||||
Effect of dilutive securities: | |||||||||||||||
Equity awards | 10 | — | 10 | — | |||||||||||
Weighted average shares of common stock outstanding, including dilutive effect | 1,227 | 380 | 1,226 | 379 | |||||||||||
Net earnings/(loss) | $ | 0.63 | $ | (0.91 | ) | $ | 1.36 | $ | (0.66 | ) |
We use the treasury stock method to calculate the dilutive effect of outstanding equity awards in the denominator for diluted earnings per common share. Due to the net loss attributable to common shareholders in the three and six months ended June 28, 2015, the dilutive effects of equity awards and warrants were excluded. Anti-dilutive shares were 3 million for the three months and 2 million for the six months ended July 3, 2016. There were no anti-dilutive shares for the three and six months ended June 28, 2015.
Note 14. Segment Reporting
We manufacture and market food and beverage products, including condiments and sauces, cheese and dairy, meals, meats, refreshment beverages, coffee, and other grocery products, throughout the world.
We manage and report our operating results through four segments. We have three reportable segments defined by geographic region: United States, Canada, and Europe. Our remaining businesses are combined and disclosed as “Rest of World”. Rest of World is comprised of three operating segments: Asia Pacific, Latin America, and Russia, India, the Middle East and Africa (“RIMEA”).
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Management evaluates segment performance based on several factors including net sales and segment adjusted earnings before interest, tax, depreciation, and amortization (“Segment Adjusted EBITDA”). Management uses Segment Adjusted EBITDA to evaluate segment performance and allocate resources. Segment Adjusted EBITDA assists management in comparing our performance on a consistent basis for purposes of business decision-making by removing the impact of certain items that management believes do not directly reflect our core operations. These items include depreciation and amortization (including amortization of postretirement benefit plans prior service credits), equity award compensation expense, integration and restructuring expenses, merger costs, unrealized gains and losses on commodity hedges (the unrealized gains and losses are recorded in general corporate expenses until realized; once realized, the gains and losses are recorded in the applicable segment's operating results), impairment losses, gains/(losses) on the sale of a business, nonmonetary currency devaluation, and certain general corporate expenses. In addition, consistent with the manner in which management evaluates segment performance and allocates resources, Segment Adjusted EBITDA includes the operating results of Kraft on a pro forma basis, as if Kraft had been acquired as of December 30, 2013. There are no pro forma adjustments to any of the numbers disclosed in this note to the condensed consolidated financial statements except for the Segment Adjusted EBITDA reconciliation.
In the first quarter of 2016, we moved certain historical Kraft export businesses from our United States segment to our Rest of World and Europe segments to align with our long-term go-to-market strategies. We began to manage and report our results reflecting this change in the first quarter of 2016 and have reflected this change in all pro forma historical information presented. The impact of this change is not material to current or prior period results. This change did not impact our Integration Program and restructuring expenses disclosed by segment in Note 3, Integration and Restructuring Expenses.
Management does not use assets by segment to evaluate performance or allocate resources and therefore, we do not disclose assets by segment.
Our net sales by segment and Segment Adjusted EBITDA were:
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
(in millions) | |||||||||||||||
Net sales: | |||||||||||||||
United States | $ | 4,692 | $ | 877 | $ | 9,407 | $ | 1,745 | |||||||
Canada | 638 | 144 | 1,142 | 265 | |||||||||||
Europe | 578 | 620 | 1,131 | 1,246 | |||||||||||
Rest of World | 885 | 975 | 1,683 | 1,838 | |||||||||||
Total net sales | $ | 6,793 | $ | 2,616 | $ | 13,363 | $ | 5,094 |
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For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
(in millions) | |||||||||||||||
Segment Adjusted EBITDA: | |||||||||||||||
United States | $ | 1,518 | $ | 1,208 | $ | 3,011 | $ | 2,331 | |||||||
Canada | 192 | 151 | 343 | 264 | |||||||||||
Europe | 212 | 225 | 389 | 439 | |||||||||||
Rest of World | 208 | 228 | 375 | 418 | |||||||||||
General corporate expenses | (43 | ) | (39 | ) | (80 | ) | (70 | ) | |||||||
Depreciation and amortization (excluding integration and restructuring expenses) | (124 | ) | (210 | ) | (285 | ) | (426 | ) | |||||||
Integration and restructuring expenses | (284 | ) | (118 | ) | (544 | ) | (199 | ) | |||||||
Merger costs | (14 | ) | (41 | ) | (29 | ) | (54 | ) | |||||||
Unrealized gains/(losses) on commodity hedges | 37 | 21 | 45 | 23 | |||||||||||
Impairment losses | (53 | ) | (58 | ) | (53 | ) | (58 | ) | |||||||
Gains/(losses) on sale of business | — | 21 | — | 21 | |||||||||||
Nonmonetary currency devaluation | (2 | ) | (49 | ) | (3 | ) | (49 | ) | |||||||
Equity award compensation expense (excluding integration and restructuring expenses) | (11 | ) | (25 | ) | (20 | ) | (44 | ) | |||||||
Other pro forma adjustments | — | (870 | ) | — | (1,643 | ) | |||||||||
Operating income | 1,636 | 444 | 3,149 | 953 | |||||||||||
Interest expense | 264 | 394 | 513 | 595 | |||||||||||
Other expense/(income), net | 6 | 245 | (2 | ) | 206 | ||||||||||
Income/(loss) before income taxes | $ | 1,366 | $ | (195 | ) | $ | 2,638 | $ | 152 |
In 2016, we reorganized the products within our product categories to reflect how we manage our business. We have reflected this change for all historical periods presented. Our net sales by product category were:
For the Three Months Ended | For the Six Months Ended | ||||||||||||||
July 3, 2016 | June 28, 2015 | July 3, 2016 | June 28, 2015 | ||||||||||||
(in millions) | |||||||||||||||
Condiments and sauces | $ | 1,824 | $ | 1,439 | $ | 3,403 | $ | 2,677 | |||||||
Cheese and dairy | 1,369 | — | 2,753 | — | |||||||||||
Ambient meals | 550 | 304 | 1,136 | 639 | |||||||||||
Frozen and chilled meals | 562 | 416 | 1,179 | 877 | |||||||||||
Meats and seafood | 740 | 51 | 1,445 | 96 | |||||||||||
Refreshment beverages | 444 | — | 851 | — | |||||||||||
Coffee | 344 | — | 736 | — | |||||||||||
Infant and nutrition | 215 | 264 | 406 | 517 | |||||||||||
Desserts, toppings and baking | 229 | — | 435 | — | |||||||||||
Nuts and salted snacks | 258 | — | 522 | — | |||||||||||
Other | 258 | 142 | 497 | 288 | |||||||||||
Total net sales | $ | 6,793 | $ | 2,616 | $ | 13,363 | $ | 5,094 |
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Note 15. Supplemental Financial Information
We fully and unconditionally guarantee the notes issued by our wholly owned operating subsidiary, Kraft Heinz Foods Company. See Note 12, Debt, to our consolidated financial statements for the year ended January 3, 2016 in our Annual Report on Form 10-K for additional descriptions of these guarantees. None of our other subsidiaries guarantee these notes.
Set forth below are the condensed consolidating financial statements presenting the results of operations, financial position and cash flows of Kraft Heinz (as parent guarantor), Kraft Heinz Foods Company (as subsidiary issuer of the notes), and the non-guarantor subsidiaries on a combined basis and eliminations necessary to arrive at the total reported information on a consolidated basis. This condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or being Registered.” This information is not intended to present the financial position, results of operations, and cash flows of the individual companies or groups of companies in accordance with U.S. GAAP. Eliminations represent adjustments to eliminate investments in subsidiaries and intercompany balances and transactions between or among the parent guarantor, subsidiary issuer, and the non-guarantor subsidiaries.
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The Kraft Heinz Company
Condensed Consolidating Statements of Income
For the Three Months Ended July 3, 2016
(in millions)
(Unaudited)
Parent Guarantor | Subsidiary Issuer | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 4,479 | $ | 2,474 | $ | (160 | ) | $ | 6,793 | ||||||||
Cost of products sold | — | 2,741 | 1,681 | (160 | ) | 4,262 | |||||||||||||
Gross profit | — | 1,738 | 793 | — | 2,531 | ||||||||||||||
Selling, general and administrative expenses | — | 307 | 588 | — | 895 | ||||||||||||||
Intercompany service fees and other recharges | — | 1,311 | (1,311 | ) | — | — | |||||||||||||
Operating income | — | 120 | 1,516 | — | 1,636 | ||||||||||||||
Interest expense | — | 253 | 11 | — | 264 | ||||||||||||||
Other expense/(income), net | — | 55 | (49 | ) | — | 6 | |||||||||||||
Income/(loss) before income taxes | — | (188 | ) | 1,554 | — | 1,366 | |||||||||||||
Provision for/(benefit from) income taxes | — | (92 | ) | 503 | — | 411 | |||||||||||||
Equity in earnings of subsidiaries | 950 | 1,046 | — | (1,996 | ) | — | |||||||||||||
Net income/(loss) | 950 | 950 | 1,051 | (1,996 | ) | 955 | |||||||||||||
Net income/(loss) attributable to noncontrolling interest | — | — | 5 | — | 5 | ||||||||||||||
Net income/(loss) excluding noncontrolling interest | $ | 950 | $ | 950 | $ | 1,046 | $ | (1,996 | ) | $ | 950 | ||||||||
Comprehensive income/(loss) excluding noncontrolling interest | $ | 577 | $ | 577 | $ | 579 | $ | (1,156 | ) | $ | 577 |
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The Kraft Heinz Company
Condensed Consolidating Statements of Income
For the Three Months Ended June 28, 2015
(in millions)
(Unaudited)
Parent Guarantor | Subsidiary Issuer | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 932 | $ | 1,741 | $ | (57 | ) | $ | 2,616 | ||||||||
Cost of products sold | — | 652 | 1,139 | (57 | ) | 1,734 | |||||||||||||
Gross profit | — | 280 | 602 | — | 882 | ||||||||||||||
Selling, general and administrative expenses | — | 166 | 272 | — | 438 | ||||||||||||||
Intercompany service fees and other recharges | — | 5 | (5 | ) | — | — | |||||||||||||
Operating income | — | 109 | 335 | — | 444 | ||||||||||||||
Interest expense | — | 360 | 34 | — | 394 | ||||||||||||||
Other expense/(income), net | — | 132 | 113 | — | 245 | ||||||||||||||
Income/(loss) before income taxes | — | (383 | ) | 188 | — | (195 | ) | ||||||||||||
Provision for/(benefit from) income taxes | — | (110 | ) | 75 | — | (35 | ) | ||||||||||||
Equity in earnings of subsidiaries | (164 | ) | 109 | — | 55 | — | |||||||||||||
Net income/(loss) | (164 | ) | (164 | ) | 113 | 55 | (160 | ) | |||||||||||
Net income/(loss) attributable to noncontrolling interest | — | — | 4 | — | 4 | ||||||||||||||
Net income/(loss) excluding noncontrolling interest | $ | (164 | ) | $ | (164 | ) | $ | 109 | $ | 55 | $ | (164 | ) | ||||||
Comprehensive income/(loss) excluding noncontrolling interest | $ | 107 | $ | 107 | $ | 349 | $ | (456 | ) | $ | 107 |
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The Kraft Heinz Company
Condensed Consolidating Statements of Income
For the Six Months Ended July 3, 2016
(in millions)
(Unaudited)
Parent Guarantor | Subsidiary Issuer | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 8,950 | $ | 4,715 | $ | (302 | ) | $ | 13,363 | ||||||||
Cost of products sold | — | 5,573 | 3,183 | (302 | ) | 8,454 | |||||||||||||
Gross profit | — | 3,377 | 1,532 | — | 4,909 | ||||||||||||||
Selling, general and administrative expenses | — | 584 | 1,176 | — | 1,760 | ||||||||||||||
Intercompany service fees and other recharges | — | 2,525 | (2,525 | ) | — | — | |||||||||||||
Operating income | — | 268 | 2,881 | — | 3,149 | ||||||||||||||
Interest expense | — | 488 | 25 | — | 513 | ||||||||||||||
Other expense/(income), net | — | 86 | (88 | ) | — | (2 | ) | ||||||||||||
Income/(loss) before income taxes | — | (306 | ) | 2,944 | — | 2,638 | |||||||||||||
Provision for/(benefit from) income taxes | — | (150 | ) | 933 | — | 783 | |||||||||||||
Equity in earnings of subsidiaries | 1,846 | 2,002 | — | (3,848 | ) | — | |||||||||||||
Net income/(loss) | 1,846 | 1,846 | 2,011 | (3,848 | ) | 1,855 | |||||||||||||
Net income/(loss) attributable to noncontrolling interest | — | — | 9 | — | 9 | ||||||||||||||
Net income/(loss) excluding noncontrolling interest | $ | 1,846 | $ | 1,846 | $ | 2,002 | $ | (3,848 | ) | $ | 1,846 | ||||||||
Comprehensive income/(loss) excluding noncontrolling interest | $ | 1,584 | $ | 1,584 | $ |