Kraft Heinz Co - Annual Report: 2019 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 28, 2019
or
☐ | 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 | 46-2078182 | |||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||
One PPG Place, | Pittsburgh, | Pennsylvania | 15222 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code: (412) 456-5700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of exchange on which registered |
Common stock, $0.01 par value | KHC | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the shares of common stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock as of the last business day of the registrant’s most recently completed second quarter, was $19 billion. As of February 8, 2020, there were 1,221,399,549 shares of the registrant’s common stock outstanding.
Documents Incorporated by Reference
Portions of the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders expected to be held on May 7, 2020 are incorporated by reference into Part III hereof.
Table of Contents
Unless the context otherwise requires, the terms “we,” “us,” “our,” “Kraft Heinz,” and the “Company” each refer to The Kraft Heinz Company and all of its consolidated subsidiaries.
Forward-Looking Statements
This Annual Report on Form 10-K contains a number of forward-looking statements. Words such as “anticipate,” “reflect,” “invest,” “see,” “make,” “expect,” “give,” “deliver,” “drive,” “believe,” “improve,” “assess,” “reassess,” “remain,” “evaluate,” “grow,” “will,” “plan,” “intend,” and variations of such words and similar future or conditional expressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our plans, impacts of accounting standards and guidance, growth, legal matters, taxes, costs and cost savings, impairments, and dividends. These forward-looking statements are not guarantees of future performance and are subject to a number of risks and uncertainties, many of which are difficult to predict and beyond our control.
Important factors that may affect our business and operations and that may cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, operating in a highly competitive industry; our ability to correctly predict, identify, and interpret changes in consumer preferences and demand, to offer new products to meet those changes, and to respond to competitive innovation; changes in the retail landscape or the loss of key retail customers; changes in our relationships with significant customers, suppliers, and other business relationships; our ability to maintain, extend, and expand our reputation and brand image; our ability to leverage our brand value to compete against private label products; our ability to drive revenue growth in our key product categories, increase our market share, or add products that are in faster-growing and more profitable categories; product recalls or product liability claims; unanticipated business disruptions; our ability to identify, complete, or realize the benefits from strategic acquisitions, alliances, divestitures, joint ventures, or other investments; our ability to realize the anticipated benefits from prior or future streamlining actions to reduce fixed costs, simplify or improve processes, and improve our competitiveness; our ability to successfully execute our strategic initiatives; the impacts of our international operations; economic and political conditions in the United States and in various other nations where we do business; changes in our management team or other key personnel and our ability to hire or retain key personnel or a highly skilled and diverse global workforce; risks associated with information technology and systems, including service interruptions, misappropriation of data, or breaches of security; impacts of natural events in the locations in which we or our customers, suppliers, distributors, or regulators operate; our ownership structure; our indebtedness and ability to pay such indebtedness, as well as our ability to comply with covenants under our debt instruments; additional impairments of the carrying amounts of goodwill or other indefinite-lived intangible assets; foreign exchange rate fluctuations; volatility in commodity, energy, and other input costs; volatility in the market value of all or a portion of the commodity derivatives we use; increased pension, labor and people-related expenses; compliance with laws, regulations, and related interpretations and related legal claims or other regulatory enforcement actions, including additional risks and uncertainties related to any potential actions resulting from the Securities and Exchange Commission’s ongoing investigation, as well as potential additional subpoenas, litigation, and regulatory proceedings; an inability to remediate the material weaknesses in our internal control over financial reporting or additional material weaknesses or other deficiencies in the future or the failure to maintain an effective system of internal controls; our failure to prepare and timely file our periodic reports; the restatement of certain of our previously issued consolidated financial statements, which resulted in unanticipated costs and may affect investor confidence and raise reputational issues; our ability to protect intellectual property rights; tax law changes or interpretations; the impact of future sales of our common stock in the public markets; our ability to continue to pay a regular dividend and the amounts of any such dividends; volatility of capital markets and other macroeconomic factors. For additional information on these and other factors that could affect our forward-looking statements, see Item 1A, Risk Factors. We disclaim and do not undertake any obligation to update or revise any forward-looking statement in this report, except as required by applicable law or regulation.
PART I
Item 1. Business.
General
For 150 years, we have produced some of the world’s most beloved products at The Kraft Heinz Company (Nasdaq: KHC). Our Vision is To Be the Best Food Company, Growing a Better World. We are one of the largest global food and beverage companies, with 2019 net sales of approximately $25 billion. Our portfolio is a diverse mix of iconic and emerging brands. As the guardians of these brands and the creators of innovative new products, we are dedicated to the sustainable health of our people and our planet.
On July 2, 2015, 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, and H. J. Heinz Company changed its name to Kraft Heinz Foods Company.
Before the consummation of the 2015 Merger, Heinz was controlled by Berkshire Hathaway Inc. (“Berkshire Hathaway”) and 3G Global Food Holdings, L.P. (“3G Capital”) (together, the “Sponsors”), following their acquisition of H. J. Heinz Company on June 7, 2013.
Reportable Segments
We manage and report our operating results through four segments. We have three reportable segments defined by geographic region: United States, Canada, and Europe, Middle East, and Africa (“EMEA”). Our remaining businesses are combined and disclosed as “Rest of World.” Rest of World comprises two operating segments: Latin America and Asia Pacific (“APAC”).
During the third quarter of 2019, certain organizational changes were announced that will impact our future internal reporting and reportable segments. As a result of these changes, we plan to combine our EMEA, Latin America, and APAC zones to form the International zone. The International zone will be a reportable segment along with the United States and Canada in 2020. We also plan to move our Puerto Rico business from the Latin America zone to the United States zone to consolidate and streamline the management of our product categories and supply chain. These changes will be effective in the first quarter of 2020.
See Note 22, Segment Reporting, in Item 8, Financial Statements and Supplementary Data, for our geographic financial information by segment.
Trademarks and Intellectual Property
Our trademarks are material to our business and are among our most valuable assets. Depending on the country, trademarks generally remain valid for as long as they are in use or their registration status is maintained. Trademark registrations generally are for renewable, fixed terms. Significant trademarks by segment based on net sales in 2019 were:
Majority Owned and Licensed Trademarks | ||
United States | Kraft, Oscar Mayer, Heinz, Philadelphia, Lunchables, Velveeta, Planters, Maxwell House, Capri Sun*, Kool-Aid, Ore-Ida, Jell-O | |
Canada | Kraft, Heinz, Philadelphia, Maxwell House, Classico, McCafe*, Tassimo* | |
EMEA | Heinz, Plasmon, Pudliszki, Honig, HP, Benedicta, Kraft, Karvan Cevitam | |
Rest of World | Heinz, ABC, Master, Kraft, Quero, Golden Circle, Wattie's |
*Used under license. Additionally, our license to use the McCafe brand expired in Canada in December 2019.
We sell certain products under brands we license from third parties. In 2019, brands used under licenses from third parties included Capri Sun packaged drink pouches for sale in the United States, TGI Fridays frozen snacks and appetizers in the United States and Canada, McCafe ground, whole bean, and on-demand single cup coffees in the United States and Canada, and Taco Bell Home Originals Mexican-style food products in U.S. grocery stores. In addition, in our agreements with Mondelēz International, Inc. (“Mondelēz International”) following the spin-off of Kraft from Mondelēz International in 2012, we each granted the other party various licenses to use certain of our and their respective intellectual property rights in named jurisdictions for certain periods of time.
We also own numerous patents worldwide. We consider our portfolio of patents, patent applications, patent licenses under patents owned by third parties, proprietary trade secrets, technology, know-how processes, and related intellectual property rights to be material to our operations. Patents, issued or applied for, cover inventions ranging from packaging techniques to processes relating to specific products and to the products themselves. While our patent portfolio is material to our business, the loss of one patent or a group of related patents would not have a material adverse effect on our business.
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Our issued patents extend for varying periods according to the date of the patent application filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage as determined by the patent office or courts in the country, and the availability of legal remedies in the country.
Research and Development
Our research and development focuses on achieving the following four objectives:
• | product innovations, renovations, and new technologies to meet changing consumer needs and drive growth; |
• | world-class and uncompromising food safety, quality, and consistency; |
• | superior, customer-preferred product and package performance; and |
• | continuous process improvement and product optimization in pursuit of cost reductions. |
Competition
Our products are sold in highly competitive marketplaces, which have experienced increased concentration and the growing presence of e-commerce retailers, large-format retailers, and discounters. Competitors include large national and international food and beverage companies and numerous local and regional companies. We compete with both branded and private label products sold by retailers, wholesalers, and cooperatives. We compete on the basis of product innovation, price, product quality, nutritional value, service, taste, convenience, brand recognition and loyalty, effectiveness of marketing and distribution, promotional activity, and the ability to identify and satisfy changing consumer preferences. Improving our market position or introducing new products requires substantial advertising and promotional expenditures.
Sales and Customers
Our products are sold through our own sales organizations and through independent brokers, agents, and distributors to chain, wholesale, cooperative and independent grocery accounts, convenience stores, drug stores, value stores, bakeries, pharmacies, mass merchants, club stores, foodservice distributors, and institutions, including hotels, restaurants, hospitals, health care facilities, and certain government agencies. Our products are also sold online through various e-commerce platforms and retailers. Our largest customer, Walmart Inc., represented approximately 21% of our net sales in 2019, 2018, and 2017.
Additionally, we have significant customers in different regions around the world; however, none of these customers are individually material to our consolidated business. In 2019, the five largest customers in our U.S. segment accounted for approximately 48% of U.S. segment net sales, the five largest customers in our Canada segment accounted for approximately 73% of Canada segment net sales, and the five largest customers in our EMEA segment accounted for approximately 26% of our EMEA segment net sales.
Net Sales by Product Category
The product categories that contributed 10% or more to consolidated net sales in any of the periods presented were:
December 28, 2019 | December 29, 2018 | December 30, 2017 | ||||||
Condiments and sauces | 26 | % | 26 | % | 25 | % | ||
Cheese and dairy | 20 | % | 20 | % | 21 | % | ||
Ambient foods | 10 | % | 10 | % | 10 | % | ||
Meats and seafood | 10 | % | 10 | % | 10 | % | ||
Frozen and chilled foods | 9 | % | 10 | % | 10 | % |
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Raw Materials and Packaging
We manufacture (and contract for the manufacture of) our products from a wide variety of raw materials. We purchase and use large quantities of commodities, including dairy products, meat products, coffee beans, nuts, tomatoes, potatoes, soybean and vegetable oils, sugar and other sweeteners, corn products, and wheat products, to manufacture our products. In addition, we purchase and use significant quantities of resins, metals, and cardboard to package our products and natural gas to operate our facilities. For commodities that we use across many of our product categories, such as corrugated paper and energy, we coordinate sourcing requirements and centralize procurement to leverage our scale. In addition, some of our product lines and brands separately source raw materials that are specific to their operations. We source these commodities from a variety of providers, including large, international producers and smaller, local, independent sellers. Where appropriate, we seek to establish preferred purchaser status and have developed strategic partnerships with many of our suppliers with the objective of achieving favorable pricing and dependable supply for many of our commodities. The prices of raw materials that we use in our products are affected by external factors, such as global competition for resources, currency fluctuations, severe weather or global climate change, consumer, industrial or investment demand, and changes in governmental regulation and trade, tariffs, alternative energy, and agricultural programs.
Our procurement teams monitor worldwide supply and cost trends so we can obtain ingredients and packaging needed for production at competitive prices. Although the prices of our principal raw materials can be expected to fluctuate, we believe there will be an adequate supply of the raw materials we use and that they are generally available from numerous sources. We use a range of hedging techniques in an effort to limit the impact of price fluctuations on many of our principal raw materials. However, we do not fully hedge against changes in commodity prices, and our hedging strategies may not protect us from increases in specific raw material costs. We actively monitor changes to commodity costs so that we can seek to mitigate the effect through pricing and other operational measures.
Seasonality and Working Capital
Although crops constituting certain of our raw food ingredients are harvested on a seasonal basis, the majority of our products are produced throughout the year.
Seasonal factors inherent in our business change the demand for products, including holidays, changes in seasons, or other annual events. While these factors influence our quarterly net sales, operating income/(loss), and cash flows at the product level, unless the timing of such events shift period-over-period (e.g., a shift in Easter timing), this seasonality does not typically have a significant effect on our consolidated results of operations or segment results.
For information related to our cash flows provided by/(used for) operating activities, including working capital items, see Liquidity and Capital Resources in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report.
Employees
We had approximately 37,000 employees as of December 28, 2019.
Regulation
The manufacture and sale of consumer food and beverage products is highly regulated. Our business operations, including the production, transportation, storage, distribution, sale, display, advertising, marketing, labeling, quality and safety of our products and their ingredients, and our occupational safety, health, and privacy practices, are subject to various laws and regulations. These laws and regulations are administered by federal, state, and local government agencies in the United States, as well as government entities and agencies outside the United States in markets where our products are manufactured, distributed or sold. In the United States, our activities are subject to regulation by various federal government agencies, including the Food and Drug Administration, U.S. Department of Agriculture, Federal Trade Commission, Department of Labor, Department of Commerce, and Environmental Protection Agency, as well as various state and local agencies. We are also subject to numerous similar and other laws and regulations outside of the United States, including but not limited to laws and regulations governing food safety, health and safety, anti-corruption, and data privacy. In our business dealings, we are also required to comply with the Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act, the Trade Sanctions Reform and Export Enhancement Act, and various other anti-corruption regulations in the regions in which we operate. We rely on legal and operational compliance programs, as well as in-house and outside counsel, to guide our businesses in complying with applicable laws and regulations of the countries in which we do business. In addition, the United Kingdom's withdrawal from the European Union (commonly referred to as “Brexit”) and other regulatory regime changes may add cost and complexity to our compliance efforts.
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Environmental Regulation
Our activities throughout the world are highly regulated and subject to government oversight regarding environmental matters. Various laws concerning the handling, storage, and disposal of hazardous materials and the operation of facilities in environmentally sensitive locations may impact aspects of our operations.
In the United States, where a significant portion of our business operates, these laws and regulations include the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”). CERCLA imposes joint and several liability on each potentially responsible party. We are involved in a number of active proceedings in the United States under CERCLA (and other similar state actions under similar legislation) related to our current operations and certain closed, inactive, or divested operations for which we retain liability.
As of December 28, 2019, we had accrued an amount we deemed appropriate for environmental remediation. Based on information currently available, we believe that the ultimate resolution of existing environmental remediation actions and our compliance in general with environmental laws and regulations will not have a material effect on our earnings or financial condition. However, it is difficult to predict with certainty the potential impact of future compliance efforts and environmental remedial actions and thus, future costs associated with such matters may exceed current reserves.
Information about our Executive Officers
The following are our executive officers as of February 8, 2020:
Name | Age | Title | ||
Miguel Patricio | 53 | Chief Executive Officer | ||
Paulo Basilio | 45 | Global Chief Financial Officer | ||
Carlos Abrams-Rivera | 52 | U.S. Zone President | ||
Nina Barton | 46 | Chief Growth Officer | ||
Bruno Keller | 38 | Zone President Canada | ||
Rashida La Lande | 46 | Senior Vice President, Global General Counsel and Head of CSR and Government Affairs; Corporate Secretary | ||
Rafael Oliveira | 45 | Zone President International | ||
Flavio Torres | 50 | Head of Global Operations |
Miguel Patricio became Chief Executive Officer in June 2019. Mr. Patricio had previously served as Chief of Special Global Projects-Marketing at Anheuser-Busch Inbev SA/NV (“AB InBev”), a multinational drink and brewing holdings company, from January 2019 to June 2019. Prior to that, he served as the Chief Marketing Officer at AB InBev since 2012. Prior to his role as Chief Marketing Officer, since joining AB InBev in 1998, he also served as Zone President Asia Pacific, Zone President North America, Vice President Marketing of North America, and Vice President Marketing. Mr. Patricio has also held several senior positions across the Americas at The Coca-Cola Company and Johnson & Johnson. Mr. Patricio also invests in the 3G Special Situation Fund III (the “Fund”); his investment represents less than 1% of the Fund’s assets.
Paulo Basilio became Global Chief Financial Officer in September 2019. Prior to that role, Mr. Basilio served as Chief Business Planning and Development Officer from July 2019 to September 2019 and served as President of the U.S. Commercial Business from October 2017 to June 2019. Mr. Basilio previously served as Executive Vice President and Chief Financial Officer upon the closing of the 2015 Merger until October 2017. He had previously served as Chief Financial Officer of Heinz since June 2013. Previously, Mr. Basilio served as Chief Executive Officer of América Latina Logística (“ALL”), a logistics company, from September 2010 to June 2012, after having served in various roles at ALL, including Chief Operating Officer and Chief Financial Officer. Mr. Basilio has also been a partner of 3G Capital since July 2012.
Carlos Abrams-Rivera joined Kraft Heinz as U.S. Zone President on February 3, 2020. Prior to joining Kraft Heinz, Mr. Abrams-Rivera served as Executive Vice President and President, Campbell Snacks of Campbell Soup Company (“Campbell”), a multinational food company, since May 2019. Prior to that role, Mr. Abrams-Rivera served as President, Campbell Snacks from 2018 to May 2019 and President of Campbell’s Pepperidge Farm subsidiary from 2015 to 2018. Prior to joining Campbell, Mr. Abrams-Rivera held various leadership roles at Mondelēz International and Kraft Foods.
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Nina Barton became Chief Growth Officer in September 2019. Prior to assuming her current role, Ms. Barton served as Zone President of Canada and President of Digital Growth from January 2019 to August 2019. Prior to that role, Ms. Barton served as President, Global Digital and Online Growth since October 2017, and from July 2015 through October 2017, she served as Senior Vice President of Marketing, Innovation and Research & Development for the U.S. business. From July 2013 through July 2015, she served as Vice President, Marketing at Kraft Foods Group, Inc. and managed the total coffee portfolio including the Maxwell House, Gevalia, and McCafe brands. Ms. Barton joined Kraft Foods in 2011 as Senior Marketing Director responsible for growing the Philadelphia cream cheese brand. Prior to that, Ms. Barton served in a variety of marketing and brand-building roles in the consumer products industry.
Bruno Keller assumed his current role as Zone President of Canada in September 2019. Previously, Mr. Keller had served as Head of Category Development for Canada since June 2018. From April 2017 to June 2018, he served as Managing Director for South Europe, and from June 2015 to April 2017, he served as Managing Director of Italy. Mr. Keller joined Kraft Heinz in 2014 as Director of Trade Marketing and Revenue Management in Italy. Prior to joining Kraft Heinz, Mr. Keller held management roles at AB InBev, Philip Morris, Pepsico, and Unilever.
Rashida La Lande joined Kraft Heinz as Senior Vice President, Global General Counsel and Corporate Secretary in January 2018. In October 2018, Ms. La Lande’s responsibilities expanded to include leadership of our corporate social responsibility and government affairs functions, and she was later appointed Head of Corporate Social Responsibility and Government Affairs in addition to her role as Senior Vice President, Global General Counsel and Corporate Secretary. Prior to joining Kraft Heinz, Ms. La Lande was a partner at the law firm of Gibson, Dunn & Crutcher, where she practiced from October 2000 to January 2018, and where she advised clients with respect to mergers and acquisitions, leveraged buyouts, private equity deals, and joint ventures. Throughout Ms. La Lande’s career, she has advised companies and private equity sponsors in the consumer products, retail, financial services, and technology industries.
Rafael Oliveira assumed his current role as Zone President International in July 2019. Prior to that role, he served as Zone President of EMEA from October 2016 to June 2019 after serving as the Managing Director of Kraft Heinz UK & Ireland. Mr. Oliveira joined Kraft Heinz in July 2014 and served as President of Kraft Heinz Australia, New Zealand, and Papua New Guinea until September 2016. Prior to joining Kraft Heinz, Mr. Oliveira spent 17 years in the financial industry, the final 10 of which he held a variety of leadership positions with Goldman Sachs.
Flavio Torres joined Kraft Heinz as Head of Global Operations in January 2020. Prior to joining Kraft Heinz, Mr. Torres served as Global Operations VP of AB InBev, a multinational drink and brewing holdings company, from 2017 to 2019. Prior to that role, Mr. Torres served as Supply Chain VP at Ambev S.A., a subsidiary of AB InBev, from 2014 to 2016. Mr. Torres joined AB InBev in 1994 and served in positions of increasing responsibility during his tenure.
Available Information
Our website address is www.kraftheinzcompany.com. The information on our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings we make with the Securities and Exchange Commission (the “SEC”). Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) are available free of charge on our website as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. In addition, the SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including Kraft Heinz, that are electronically filed with the SEC.
Item 1A. Risk Factors.
Industry Risks
We operate in a highly competitive industry.
The food and beverage industry is highly competitive across all of our product offerings. Our principal competitors in these categories are manufacturers, as well as retailers with their own branded and private label products. We compete based on product innovation, price, product quality, nutritional value, service, taste, convenience, brand recognition and loyalty, effectiveness of marketing and distribution, promotional activity, and the ability to identify and satisfy changing consumer preferences.
We may need to reduce our prices in response to competitive and customer pressures, including pressures in relation to private label products that are generally sold at lower prices. These pressures have restricted and may in the future continue to restrict our ability to increase prices in response to commodity and other cost increases. Failure to effectively assess, timely change and set proper pricing, promotions, or trade incentives may negatively impact the achievement of our objectives.
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The rapid emergence of new distribution channels, particularly e-commerce, may create consumer price deflation, affecting our retail customer relationships and presenting additional challenges to increasing prices in response to commodity or other cost increases. We may also need to increase or reallocate spending on marketing, retail trade incentives, materials, advertising, and new product or channel innovation to maintain or increase market share. These expenditures are subject to risks, including uncertainties about trade and consumer acceptance of our efforts. If we are unable to compete effectively, our profitability, financial condition, and operating results may decline.
Our success depends on our ability to correctly predict, identify, and interpret changes in consumer preferences and demand, to offer new products to meet those changes, and to respond to competitive innovation.
Consumer preferences for food and beverage products change continually and rapidly. Our success depends on our ability to predict, identify, and interpret the tastes and dietary habits of consumers and to offer products that appeal to consumer preferences, including with respect to health and wellness. If we do not offer products that appeal to consumers, our sales and market share will decrease, which could materially and adversely affect our product sales, financial condition, and operating results.
We must distinguish between short-term trends and long-term changes in consumer preferences. If we do not accurately predict which shifts in consumer preferences will be long-term, or if we fail to introduce new and improved products to satisfy those preferences, our sales could decline. In addition, because of our varied consumer base, we must offer an array of products that satisfy a broad spectrum of consumer preferences. If we fail to expand our product offerings successfully across product categories, or if we do not rapidly develop products in faster-growing or more profitable categories, demand for our products could decrease, which could materially and adversely affect our product sales, financial condition, and operating results.
Prolonged negative perceptions concerning the health implications of certain food and beverage products (including as they relate to obesity or other health concerns) could influence consumer preferences and acceptance of some of our products and marketing programs. We strive to respond to consumer preferences and social expectations, but we may not be successful in our efforts. Continued negative perceptions and failure to satisfy consumer preferences could materially and adversely affect our product sales, financial condition, and operating results.
In addition, achieving growth depends on our successful development, introduction, and marketing of innovative new products and line extensions. There are inherent risks associated with new product or packaging introductions, including uncertainties about trade and consumer acceptance or potential impacts on our existing product offerings. We may be required to increase expenditures for new product development. Successful innovation depends on our ability to correctly anticipate customer and consumer acceptance, to obtain, protect, and maintain necessary intellectual property rights, and to avoid infringing upon the intellectual property rights of others. We must also be able to respond successfully to technological advances by and intellectual property rights of our competitors, and failure to do so could compromise our competitive position and impact our product sales, financial condition, and operating results.
Changes in the retail landscape or the loss of key retail customers could adversely affect our financial performance.
Retail customers, such as supermarkets, warehouse clubs, and food distributors in our major markets, may continue to consolidate, resulting in fewer but larger customers for our business across various channels. Consolidation also produces larger retail customers that may seek to leverage their positions to improve their profitability by demanding improved efficiency, lower pricing, more favorable terms, increased promotional programs, or specifically-tailored product offerings. In addition, larger retailers have scale to develop supply chains that permit them to operate with reduced inventories or to develop and market their own private label products. Retail consolidation and increasing retailer power could materially and adversely affect our product sales, financial condition, and operating results.
Retail consolidation also increases the risk that adverse changes in our customers’ business operations or financial performance may have a corresponding material and adverse effect on us. For example, if our customers cannot access sufficient funds or financing, then they may delay, decrease, or cancel purchases of our products, or delay or fail to pay us for previous purchases, which could materially and adversely affect our product sales, financial condition, and operating results.
In addition, technology-based systems, which give consumers the ability to shop through e-commerce websites and mobile commerce applications, are also significantly altering the retail landscape in many of our markets. If we are unable to adjust to developments in these changing landscapes, we may be disadvantaged in key channels and with certain consumers, which could materially and adversely affect our product sales, financial condition, and operating results.
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Changes in our relationships with significant customers, suppliers, or other business relationships could adversely impact us.
We derive significant portions of our sales from certain significant customers (see Sales and Customers within Item 1, Business). There can be no assurance that all of our significant customers will continue to purchase our products in the same mix or quantities or on the same terms as in the past, particularly as increasingly powerful retailers may demand lower pricing and focus on developing their own brands. The loss of a significant customer or a material reduction in sales or a change in the mix of products we sell to a significant customer could materially and adversely affect our product sales, financial condition, and operating results.
Disputes with significant suppliers, including disputes related to pricing or performance, could adversely affect our ability to supply products to our customers and could materially and adversely affect our product sales, financial condition, and operating results. In addition, terminations of relationships with other significant contractual counterparties, including licensors, could adversely affect our portfolio, product sales, financial condition, and operating results.
In addition, the financial condition of such customers, suppliers, and other significant contractual counterparties are affected in large part by conditions and events that are beyond our control. Significant deteriorations in the financial conditions of significant customers, suppliers, and other business relationships could materially and adversely affect our product sales, financial condition, and operating results.
Maintaining, extending, and expanding our reputation and brand image are essential to our business success.
We have many iconic brands with long-standing consumer recognition across the globe. Our success depends on our ability to maintain brand image for our existing products, extend our brands to new platforms, and expand our brand image with new product offerings.
We seek to maintain, extend, and expand our brand image through marketing investments, including advertising and consumer promotions, and product innovation. Negative perceptions on the role of food and beverage marketing could adversely affect our brand image or lead to stricter regulations and scrutiny of marketing practices. Moreover, adverse publicity about legal or regulatory action against us, our quality and safety, our environmental or social impacts, our products becoming unavailable to consumers, or our suppliers and, in some cases, our competitors, could damage our reputation and brand image, undermine our customers’ confidence, and reduce demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Furthermore, existing or increased legal or regulatory restrictions on our advertising, consumer promotions, and marketing, or our response to those restrictions, could limit our efforts to maintain, extend, and expand our brands.
In addition, our success in maintaining, extending, and expanding our brand image depends on our ability to adapt to a rapidly changing media environment. We increasingly rely on social media and online dissemination of advertising campaigns. The growing use of social and digital media increases the speed and extent that information, including misinformation, and opinions can be shared. Negative posts or comments about us, our brands or our products, or our suppliers and, in some cases, our competitors, on social or digital media, whether or not valid, could seriously damage our brands and reputation. In addition, we might fail to appropriately target our marketing efforts, anticipate consumer preferences, or invest sufficiently in maintaining, extending, and expanding our brand image. If we do not maintain, extend, and expand our reputation or brand image, then our product sales, financial condition, and operating results could be materially and adversely affected.
We must leverage our brand value to compete against private label products.
In nearly all of our product categories, we compete with branded products as well as private label products, which are typically sold at lower prices. Our products must provide higher value and/or quality to our consumers than alternatives, particularly during periods of economic uncertainty. Consumers may not buy our products if relative differences in value and/or quality between our products and private label products change in favor of competitors’ products or if consumers perceive this type of change. If consumers prefer private label products, then we could lose market share or sales volumes or shift our product mix to lower margin offerings. A change in consumer preferences could also cause us to increase capital, marketing, and other expenditures, which could materially and adversely affect our product sales, financial condition, and operating results.
We may be unable to drive revenue growth in our key product categories, increase our market share, or add products that are in faster-growing and more profitable categories.
Our future results will depend on our ability to drive revenue growth in our key product categories and growth in the food and beverage industry in the countries in which we operate. Our future results will also depend on our ability to enhance our portfolio by adding innovative new products in faster-growing and more profitable categories and our ability to increase market share in our existing product categories. Our failure to drive revenue growth, limit market share decreases in our key product categories, or develop innovative products for new and existing categories could materially and adversely affect our product sales, financial condition, and operating results.
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Product recalls or other product liability claims could materially and adversely affect us.
Selling products for human consumption involves inherent legal and other risks, including product contamination, spoilage, product tampering, allergens, or other adulteration. We have decided and could in the future decide to, and have been or could in the future be required to, recall products due to suspected or confirmed product contamination, adulteration, product mislabeling or misbranding, tampering, undeclared allergens, or other deficiencies. Product recalls or market withdrawals could result in significant losses due to their costs, the destruction of product inventory, and lost sales due to the unavailability of the product for a period of time.
We could be adversely affected if consumers lose confidence in the safety and quality of certain food products or ingredients, or the food safety system generally. Adverse attention about these types of concerns, whether or not valid, may damage our reputation, discourage consumers from buying our products, or cause production and delivery disruptions that could negatively impact our net sales and financial condition.
We may also suffer losses if our products or operations violate applicable laws or regulations, or if our products cause injury, illness, or death. In addition, our marketing could face claims of false or deceptive advertising or other criticism. A significant product liability or other legal judgment or a related regulatory enforcement action against us, or a significant product recall, may materially and adversely affect our reputation and profitability. Moreover, even if a product liability or fraud claim is unsuccessful, has no merit, or is not pursued, the negative publicity surrounding assertions against our products or processes could materially and adversely affect our product sales, financial condition, and operating results.
Unanticipated business disruptions could adversely affect our ability to provide our products to our customers.
We have a complex network of suppliers, owned and leased manufacturing locations, co-manufacturing locations, distribution networks, and information systems that support our ability to consistently provide our products to our customers. Factors that are hard to predict or beyond our control, such as weather, raw material shortages, natural disasters, fires or explosions, political unrest, terrorism, generalized labor unrest, or health pandemics, such as the new coronavirus that originated in China, could damage or disrupt our operations or our suppliers’, co-manufacturers’ or distributors’ operations. These disruptions may require additional resources to restore our supply chain or distribution network. If we cannot respond to disruptions in our operations, whether by finding alternative suppliers or replacing capacity at key manufacturing or distribution locations, or if we are unable to quickly repair damage to our information, production, or supply systems, we may be late in delivering, or be unable to deliver, products to our customers and may also be unable to track orders, inventory, receivables, and payables. If that occurs, our customers’ confidence in us and long-term demand for our products could decline. Any of these events could materially and adversely affect our product sales, financial condition, and operating results.
Business Risks
We may not successfully identify, complete, or realize the benefits from strategic acquisitions, alliances, divestitures, joint ventures, or other investments.
From time to time, we have evaluated and may continue to evaluate acquisition candidates, alliances, joint ventures, or other investments that may strategically fit our business objectives, and we have divested and may consider divesting businesses that do not meet our strategic objectives or growth or profitability targets. These activities may present financial, managerial, and operational risks including, but not limited to, diversion of management’s attention from existing core businesses, difficulties integrating or separating personnel and financial and other systems, inability to effectively and immediately implement control environment processes across a diverse employee population, adverse effects on existing or acquired customer and supplier business relationships, and potential disputes with buyers, sellers, or partners. Activities in such areas are regulated by numerous antitrust and competition laws in the United States, Canada, the European Union, and other jurisdictions, and we may be required to obtain the approval of these transactions by competition authorities, as well as to satisfy other legal requirements.
To the extent we undertake acquisitions, alliances, joint ventures, investments, or other developments outside our core regions or in new categories, we may face additional risks related to such developments. For example, risks related to foreign operations include compliance with U.S. laws affecting operations outside of the United States, such as the FCPA, currency rate fluctuations, compliance with foreign regulations and laws, including tax laws, and exposure to politically and economically volatile developing markets. Any of these factors could materially and adversely affect our product sales, financial condition, and operating results.
To the extent we undertake divestitures, we may face additional risks related to such activity. For example, risks related to our ability to find appropriate buyers, to execute transactions on favorable terms, to separate divested businesses from our remaining operations, and to effectively manage any transitional service arrangements. Any of these factors could materially and adversely affect our financial condition and operating results.
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We may be unable to realize the anticipated benefits from prior or future streamlining actions to reduce fixed costs, simplify or improve processes, and improve our competitiveness.
We have implemented a number of cost savings initiatives, including our multi-year program announced following the 2015 Merger, that we believe are important to position our business for future success and growth. We have evaluated and continue to evaluate changes to our organizational structure to enable us to reduce costs, simplify or improve processes, and improve our competitiveness. Our future success may depend upon our ability to realize the benefits of these or other cost savings initiatives. In addition, certain of our initiatives may lead to increased costs in other aspects of our business such as increased conversion, outsourcing, or distribution costs. We must accurately predict costs and be efficient in executing any plans to achieve cost savings and operate efficiently in the highly competitive food and beverage industry, particularly in an environment of increased competitive activity. To capitalize on our efforts, we must carefully evaluate investments in our business, and execute in those areas with the most potential return on investment. If we are unable to realize the anticipated benefits from any cost-saving efforts, we could be cost disadvantaged in the marketplace, and our competitiveness, production, profitability, financial condition, and operating results could be adversely affected.
We may not be able to successfully execute our strategic initiatives.
We plan to continue to conduct strategic initiatives in various markets. Consumer demands, behaviors, tastes and purchasing trends may differ in these markets and, as a result, our sales may not be successful or meet expectations, or the margins on those sales may be less than currently anticipated. We may also face difficulties integrating new business operations with our current sourcing, distribution, information technology systems, and other operations. Any of these challenges could hinder our success in new markets or new distribution channels. We may also face difficulties divesting business operations with minimal impact to the retained businesses. There can be no assurance that we will successfully complete any planned strategic initiatives, that any new business will be profitable or meet our expectations, or that any divestiture will be completed without disruption, which could adversely affect our results of operations and financial condition.
Our international operations subject us to additional risks and costs and may cause our profitability to decline.
We are a global company with sales and operations in numerous countries within developed and emerging markets. Approximately 29% of our 2019 net sales were generated outside of the United States. As a result, we are subject to risks inherent in global operations. These risks, which can vary substantially by market, are described in many of the risk factors discussed in this section and also include:
• | compliance with U.S. laws affecting operations outside of the United States, including anti-bribery laws such as the FCPA; |
• | changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws or their interpretations, or tax audit implications; |
• | the imposition of increased or new tariffs, quotas, trade barriers, or similar restrictions on our sales or imports, trade agreements, regulations, taxes, or policies that might negatively affect our sales or costs; |
• | currency devaluations or fluctuations in currency values; |
• | compliance with antitrust and competition laws, data privacy laws, and a variety of other local, national, and multi-national regulations and laws in multiple jurisdictions; |
• | discriminatory or conflicting fiscal policies in or across foreign jurisdictions; |
• | changes in capital controls, including currency exchange controls, government currency policies, or other limits on our ability to import raw materials or finished product into various countries or repatriate cash from outside the United States; |
• | challenges associated with cross-border product distribution; |
• | changes in local regulations and laws, the uncertainty of enforcement of remedies in foreign jurisdictions, and foreign ownership restrictions and the potential for nationalization or expropriation of property or other resources; |
• | risks and costs associated with political and economic instability, corruption, anti-American sentiment, and social and ethnic unrest in the countries in which we operate; |
• | the risks of operating in developing or emerging markets in which there are significant uncertainties regarding the interpretation, application, and enforceability of laws and regulations and the enforceability of contract rights and intellectual property rights; |
• | risks arising from the significant and rapid fluctuations in currency exchange markets and the decisions made and positions taken to hedge such volatility; |
• | changing labor conditions and difficulties in staffing our operations; |
• | greater risk of uncollectible accounts and longer collection cycles; and |
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• | design, implementation, and use of effective control environment processes across our diverse operations and employee base. |
In addition, political and economic changes or volatility, geopolitical conflicts, terrorist activity, political unrest, civil strife, acts of war, public corruption, expropriation, and other economic or political uncertainties could interrupt and negatively affect our business operations or customer demand. Slow economic growth or high unemployment in the markets in which we operate could constrain consumer spending, and declining consumer purchasing power could adversely impact our profitability. All of these factors could result in increased costs or decreased sales, and could materially and adversely affect our product sales, financial condition, and results of operations.
Our performance may be adversely affected by economic and political conditions in the United States and in various other nations where we do business.
Our performance has been in the past and may continue in the future to be impacted by economic and political conditions in the United States and in other nations where we do business. Economic and financial uncertainties in our international markets, including uncertainties surrounding the legal and regulatory effects of Brexit in the transition period and beyond, changes to major international trade arrangements (e.g., the United States-Mexico-Canada Agreement), and the imposition of tariffs by certain foreign governments, including China and Canada, could negatively impact our operations and sales. Though the United Kingdom formally withdrew from the European Union on January 31, 2020, the uncertainties around the impacts of Brexit remain during the transition period and while a new trade agreement is negotiated. As a result, we continue to evaluate the risks associated with the withdrawal, including the potential for supply chain disruptions and foreign currency volatility. Other factors impacting our operations in the United States and in international locations where we do business include export and import restrictions, currency exchange rates, currency devaluation, cash repatriation restrictions, recessionary conditions, foreign ownership restrictions, nationalization, the impact of hyperinflationary environments, terrorist acts, and political unrest. Such factors in either domestic or foreign jurisdictions, and our responses to them, could materially and adversely affect our product sales, financial condition, and operating results. For further information on Venezuela, see Note 15, Venezuela - Foreign Currency and Inflation, in Item 8, Financial Statements and Supplementary Data.
We rely on our management team and other key personnel and may be unable to hire or retain key personnel or a highly skilled and diverse global workforce.
We depend on the skills, working relationships, and continued services of key personnel, including our experienced management team. In addition, our ability to achieve our operating goals depends on our ability to identify, hire, train, and retain qualified individuals. We compete with other companies both within and outside of our industry for talented personnel, and we may lose key personnel or fail to attract, train, and retain other talented personnel and a diverse global workforce with the skills and in the locations we need to operate and grow our business. Unplanned turnover, failure to attract and develop personnel with key emerging capabilities such as e-commerce and digital marketing skills, or failure to develop adequate succession plans for leadership positions, including the Chief Executive Officer position, could deplete our institutional knowledge base and erode our competitiveness. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate skilled employees. Any such loss, failure, or limitation could adversely affect our product sales, financial condition, and operating results.
We are significantly dependent on information technology, and we may be unable to protect our information systems against service interruption, misappropriation of data, or breaches of security.
We rely on information technology networks and systems, including the Internet, to process, transmit, and store electronic and financial information, to manage a variety of business processes and activities, and to comply with regulatory, legal, and tax requirements. We also depend on our information technology infrastructure for digital marketing activities and for electronic communications among our locations, personnel, customers, and suppliers. These information technology systems, some of which are managed by third parties, may be susceptible to damage, invasions, disruptions, or shutdowns due to hardware failures, computer viruses, hacker attacks and other cybersecurity risks, telecommunication failures, user errors, catastrophic events or other factors. If our information technology systems suffer severe damage, disruption, or shutdown, by unintentional or malicious actions of employees and contractors or by cyberattacks, and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience business disruptions, reputational damage, transaction errors, processing inefficiencies, the leakage of confidential information, and the loss of customers and sales, causing our product sales, financial condition, and operating results to be adversely affected and the reporting of our financial results to be delayed.
In addition, if we are unable to prevent security breaches or disclosure of non-public information, we may suffer financial and reputational damage, litigation or remediation costs, fines, or penalties because of the unauthorized disclosure of confidential information belonging to us or to our partners, customers, consumers, or suppliers.
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Misuse, leakage, or falsification of information could result in violations of data privacy laws and regulations, damage to our reputation and credibility, loss of opportunities to acquire or divest of businesses or brands, and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net sales. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, or to our suppliers or consumers, and may become subject to legal action and increased regulatory oversight. We could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems.
We are also subject to various laws and regulations that are continuously evolving and developing regarding privacy, data protection, and data security, including those related to the collection, storage, handling, use, disclosure, transfer, and security of personal data. Such laws and regulations, as well as their interpretation and application, may vary from jurisdiction to jurisdiction, which can result in inconsistent or conflicting requirements. The European Union’s General Data Protection Regulation (“GDPR”), which became effective in May 2018, adds a broad array of requirements with respect to personal data, including the public disclosure of significant data breaches, and imposes substantial penalties for non-compliance. The California Consumer Privacy Act (“CCPA”), which became effective on January 1, 2020, among other things, imposes additional requirements with respect to disclosure and deletion of personal information of California residents. The CCPA provides civil penalties for violations, as well as a private right of action for data breaches. GDPR, CCPA, and other privacy and data protection laws may increase our costs of compliance and risks of non-compliance, which could result in substantial penalties.
Our results of operations could be affected by natural events in the locations in which we or our customers, suppliers, distributors, or regulators operate.
We have been and may in the future be impacted by severe weather and other geological events, including hurricanes, earthquakes, floods, or tsunamis that could disrupt our operations or the operations of our customers, suppliers, distributors, or regulators. Natural disasters or other disruptions at any of our facilities or our suppliers’ or distributors’ facilities may impair or delay the delivery of our products. Influenza or other pandemics, such as the new coronavirus that originated in China, could disrupt production of our products, reduce demand for certain of our products, or disrupt the marketplace in the foodservice or retail environment with consequent material adverse effects on our results of operations. While we insure against many of these events and certain business interruption risks and have policies and procedures to manage business continuity planning, we cannot provide any assurance that such insurance will compensate us for any losses incurred as a result of natural or other disasters or that our business continuity plans will effectively resolve the issues in a timely manner. To the extent we are unable to, or cannot, financially mitigate the likelihood or potential impact of such events, or effectively manage such events if they occur, particularly when a product is sourced from a single location, there could be a material adverse effect on our business and results of operations, and additional resources could be required to restore our supply chain.
The Sponsors have substantial control over us and may have conflicts of interest with us in the future.
As of December 28, 2019, the Sponsors own approximately 47% of our common stock. Three of our current 11 directors had been directors of Heinz prior to the closing of the 2015 Merger and remained directors of Kraft Heinz pursuant to the merger agreement. In addition, the Board elected Joao M. Castro-Neves, a partner of 3G Capital, one of the Sponsors, effective June 12, 2019. Furthermore, Paulo Basilio, our Chief Financial Officer, is a partner of 3G Capital. As a result, the Sponsors have the potential to exercise influence over management and have substantial control over decisions of our Board of Directors as well as over any action requiring the approval of the holders of our common stock, including adopting any amendments to our charter, electing directors, and approving mergers or sales of substantially all of our capital stock or our assets. In addition, to the extent that the Sponsors were to collectively hold a majority of our common stock, they together would have the power to take shareholder action by written consent to adopt amendments to our charter or take other actions, such as corporate transactions, that require the vote of holders of a majority of our outstanding common stock. The directors designated by the Sponsors may have significant authority to effect decisions affecting our capital structure, including the issuance of additional capital stock, the incurrence of additional indebtedness, the implementation of stock repurchase programs, and the decision of whether to declare dividends and the amount of any such dividends. Additionally, the Sponsors are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. The Sponsors may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. So long as the Sponsors continue to own a significant amount of our equity, they will continue to be able to strongly influence or effectively control our decisions.
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Financial Risks
Our level of indebtedness, as well as our ability to comply with covenants under our debt instruments, could adversely affect our business and financial condition.
We have a substantial amount of indebtedness, and are permitted to incur a substantial amount of additional indebtedness, including secured debt. Our existing debt, together with any incurrence of additional indebtedness, could have important consequences, including, but not limited to:
• | increasing our vulnerability to general adverse economic and industry conditions; |
• | limiting our ability to obtain additional financing for working capital, capital expenditures, research and development, debt service requirements, acquisitions, and general corporate or other purposes; |
• | resulting in a downgrade to our credit rating, which could adversely affect our cost of funds, including our commercial paper programs; liquidity; and access to capital markets; |
• | restricting us from making strategic acquisitions or causing us to make non-strategic divestitures; |
• | limiting our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors who are not as highly leveraged; |
• | making it more difficult for us to make payments on our existing indebtedness; |
• | requiring a substantial portion of cash flows from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, payments of dividends, capital expenditures, and future business opportunities; |
• | exposing us to risks related to fluctuations in foreign currency, as we earn profits in a variety of currencies around the world and the majority of our debt is denominated in U.S. dollars; and |
• | in the case of any additional indebtedness, exacerbating the risks associated with our substantial financial leverage. |
In addition, there can be no assurance that we will generate sufficient cash flow from operations or that future debt or equity financings will be available to us to enable us to pay our indebtedness or to fund other needs. As a result, we may need to refinance all or a portion of our indebtedness on or before maturity. There is no assurance that we will be able to refinance any of our indebtedness on favorable terms, or at all. Any inability to generate sufficient cash flow or to refinance our indebtedness on favorable terms could have a material adverse effect on our financial condition.
Our indebtedness instruments contain customary representations, warranties and covenants, including a financial covenant in our senior unsecured revolving credit facility (the “Senior Credit Facility”) to maintain a minimum shareholders’ equity (excluding accumulated other comprehensive income/(losses)). The creditors who hold our debt could accelerate amounts due in the event that we default, which could potentially trigger a default or acceleration of the maturity of our other debt. If our operating performance declines, or if we are unable to comply with any covenant, such as our ability to timely prepare and file our periodic reports with the SEC, we have in the past and may in the future need to obtain waivers from the required creditors under our indebtedness instruments to avoid being in default.
If we breach any covenants under our indebtedness instruments and seek a waiver, we may not be able to obtain a waiver from the required creditors, or we may not be able to remedy compliance within the terms of any waivers approved by the required creditors. If this occurs, we would be in default under our indebtedness instruments and unable to access our Senior Credit Facility. In addition, certain creditors could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.
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Additional impairments of the carrying amounts of goodwill or other indefinite-lived intangible assets could negatively affect our financial condition and results of operations.
We maintain 19 reporting units, 11 of which comprise our goodwill balance. Our indefinite-lived intangible asset balance primarily consists of a number of individual brands. We test our reporting units and brands for impairment annually as of the first day of our second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit or brand is less than its carrying amount. Such events and circumstances could include a sustained decrease in our market capitalization, increased competition or unexpected loss of market share, increased input costs beyond projections (for example due to regulatory or industry changes), disposals of significant brands or components of our business, unexpected business disruptions (for example due to a natural disaster or loss of a customer, supplier, or other significant business relationship), unexpected significant declines in operating results, significant adverse changes in the markets in which we operate, or changes in management strategy. We test reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. We test brands for impairment by comparing the estimated fair value of each brand with its carrying amount. If the carrying amount of a reporting unit or brand exceeds its estimated fair value, we record an impairment loss based on the difference between fair value and carrying amount, in the case of reporting units, not to exceed the associated carrying amount of goodwill.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units and brands requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax considerations, discount rates, growth rates, royalty rates, contributory asset charges, and other market factors. If current expectations of future growth rates and margins are not met, if market factors outside of our control, such as discount rates, change, or if management’s expectations or plans otherwise change, including as a result of updates to our global five-year operating plan, then one or more of our reporting units or brands might become impaired in the future, which could negatively affect our operating results or net worth. We are currently actively reviewing the enterprise strategy for the Company. As part of this strategic review, we expect to develop updates to the five-year operating plan in 2020, which could impact the allocation of investments among reporting units and brands and impact growth expectations and fair value estimates. Additionally, as a result of this strategic review process, we could decide to divest certain non-strategic assets. As a result, the ongoing development of the enterprise strategy and underlying detailed business plans could lead to the impairment of one or more of our reporting units or brands in the future.
As a result of our annual and interim impairment tests, we recognized goodwill impairment losses of $7.0 billion and indefinite-lived intangible asset impairment losses of $8.9 billion in 2018, and goodwill impairment losses of $1.2 billion and indefinite-lived intangible asset impairment losses of $687 million in 2019. Our reporting units and brands that were impaired in 2018 and 2019 were written down to their respective fair values resulting in zero excess fair value over carrying amount as of the applicable impairment test dates. Accordingly, these and other individual reporting units and brands that have 20% or less excess fair value over carrying amount as of their latest 2019 impairment testing date have a heightened risk of future impairments if any assumptions, estimates, or market factors change in the future. Reporting units with 10% or less fair value over carrying amount had an aggregate goodwill carrying amount of $32.4 billion as of their latest 2019 impairment testing date and included U.S. Grocery, U.S. Refrigerated, U.S. Foodservice, Canada Retail, Canada Foodservice, Latin America Exports, and EMEA East. Reporting units with between 10-20% fair value over carrying amount had an aggregate goodwill carrying amount of $676 million as of their latest 2019 impairment testing date and included Continental Europe and Northeast Asia. The aggregate goodwill carrying amount of reporting units with fair value over carrying amount between 20-50% was $2.4 billion and there were no reporting units with fair value over carrying amount in excess of 50% as of their latest 2019 impairment testing date. Brands with 10% or less fair value over carrying amount had an aggregate carrying amount after impairment of $26.2 billion as of their latest 2019 impairment testing date and included: Kraft, Philadelphia, Velveeta, Lunchables, Miracle Whip, Planters, Maxwell House, Cool Whip, and ABC. Brands with between 10-20% fair value over carrying amount had an aggregate carrying amount of $3.7 billion as of their latest 2019 impairment testing date and included Oscar Mayer, Jet Puffed, Wattie’s, and Quero. The aggregate carrying amount of brands with fair value over carrying amount between 20-50% was $4.2 billion as of their latest 2019 impairment testing date. Although the remaining brands have more than 50% excess fair value over carrying amount as of their latest 2019 impairment testing date, these amounts are also associated with the 2013 Heinz acquisition and the 2015 Merger and are recorded on the balance sheet at their estimated acquisition date fair values. Therefore, if any estimates, market factors, or assumptions, including those related to our enterprise strategy or business plans, change in the future, these amounts are also susceptible to impairments.
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Our net sales and net income may be exposed to foreign exchange rate fluctuations.
We derive a substantial portion of our net sales from international operations. We hold assets and incur liabilities, earn revenue, and pay expenses in a variety of currencies other than the U.S. dollar, primarily the British pound sterling, euro, Australian dollar, Canadian dollar, New Zealand dollar, Brazilian real, Indonesian rupiah, Chinese renminbi, and Indian rupee. Since our consolidated financial statements are reported in U.S. dollars, fluctuations in exchange rates from period to period will have an impact on our reported results. We have implemented currency hedges intended to reduce our exposure to changes in foreign currency exchange rates. However, these hedging strategies may not be successful, and any of our unhedged foreign exchange exposures will continue to be subject to market fluctuations. In addition, in certain circumstances, we may incur costs in one currency related to services or products for which we are paid in a different currency. As a result, factors associated with international operations, including changes in foreign currency exchange rates, could significantly affect our results of operations and financial condition.
Commodity, energy, and other input prices are volatile and could negatively affect our consolidated operating results.
We purchase and use large quantities of commodities, including dairy products, meat products, coffee beans, nuts, tomatoes, potatoes, soybean and vegetable oils, sugar and other sweeteners, corn products, wheat products, cucumbers, onions, other fruits and vegetables, spices, cocoa products, and flour to manufacture our products. In addition, we purchase and use significant quantities of resins, metals, cardboard, glass, plastic, paper, fiberboard, and other materials to package our products, and we use other inputs, such as natural gas and water, to operate our facilities. We are also exposed to changes in oil prices, which influence both our packaging and transportation costs. Prices for commodities, energy, and other supplies are volatile and can fluctuate due to conditions that are difficult to predict, including global competition for resources, currency fluctuations, severe weather or global climate change, crop failures, or shortages due to plant disease or insect and other pest infestation, consumer, industrial, or investment demand, and changes in governmental regulation and trade, tariffs, alternative energy, including increased demand for biofuels, and agricultural programs. Additionally, we may be unable to maintain favorable arrangements with respect to the costs of procuring raw materials, packaging, services, and transporting products, which could result in increased expenses and negatively affect our operations. Furthermore, the cost of raw materials and finished products may fluctuate due to movements in cross-currency transaction rates. Rising commodity, energy, and other input costs could materially and adversely affect our cost of operations, including the manufacture, transportation, and distribution of our products, which could materially and adversely affect our financial condition and operating results.
Although we monitor our exposure to commodity prices as an integral part of our overall risk management program, and seek to hedge against input price increases to the extent we deem appropriate, we do not fully hedge against changes in commodity prices, and our hedging strategies may not protect us from increases in specific raw materials costs. For example, hedging our costs for one of our key commodities, dairy products, is difficult because dairy futures markets are not as developed as many other commodities futures markets. Continued volatility or sustained increases in the prices of commodities and other supplies we purchase could increase the costs of our products, and our profitability could suffer. Moreover, increases in the prices of our products to cover these increased costs may result in lower sales volumes, or we may be constrained from increasing the prices of our products by competitive and consumer pressures. If we are not successful in our hedging activities, or if we are unable to price our products to cover increased costs, then commodity and other input price volatility or increases could materially and adversely affect our financial condition and operating results.
Volatility in the market value of all or a portion of the derivatives we use to manage exposures to fluctuations in commodity prices may cause volatility in our gross profit and net income.
We use commodity futures, options, and swaps to economically hedge the price of certain input costs, including dairy products, meat products, coffee beans, sugar, vegetable oils, wheat products, corn products, cocoa products, packaging products, diesel fuel, and natural gas. We recognize gains and losses based on changes in the values of these commodity derivatives. We recognize these gains and losses in cost of products sold in our consolidated statements of income to the extent we utilize the underlying input in our manufacturing process. We recognize these gains and losses in general corporate expenses in our segment operating results until we sell the underlying products, at which time we reclassify the gains and losses to segment operating results. Accordingly, changes in the values of our commodity derivatives may cause volatility in our gross profit and net income.
Our results could be adversely impacted as a result of increased pension, labor, and people-related expenses.
Inflationary pressures and any shortages in the labor market could increase labor costs, which could have a material adverse effect on our consolidated operating results or financial condition. Our labor costs include the cost of providing employee benefits in the United States, Canada, and other foreign jurisdictions, including pension, health and welfare, and severance benefits. Any declines in market returns could adversely impact the funding of pension plans, the assets of which are invested in a diversified portfolio of equity and fixed-income securities and other investments. Additionally, the annual costs of benefits vary with increased costs of health care and the outcome of collectively-bargained wage and benefit agreements.
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Furthermore, we may be subject to increased costs or experience adverse effects to our operating results if we are unable to renew collectively bargained agreements on satisfactory terms. Our financial condition and ability to meet the needs of our customers could be materially and adversely affected if strikes or work stoppages and interruptions occur as a result of delayed negotiations with union-represented employees both in and outside of the United States.
Regulatory Risks
Compliance with laws, regulations, and related interpretations and related legal claims or other regulatory enforcement actions could impact our business, and we face additional risks and uncertainties related to any potential actions resulting from the SEC’s ongoing investigation, as well as potential additional subpoenas, litigation, and regulatory proceedings.
As a large, global food and beverage company, we operate in a highly-regulated environment with constantly-evolving legal and regulatory frameworks. Various laws and regulations govern production, storage, distribution, sales, advertising, labeling, including on-pack claims, information or disclosures, marketing, licensing, trade, labor, tax, environmental matters, privacy, as well as health and safety and data protection practices. Government authorities regularly change laws and regulations and their interpretations. In particular, Brexit could result in a new regulatory regime in the United Kingdom that may or may not follow that of the European Union, and the creation of new and divergent laws and regulations could increase the cost and complexity of our compliance. In addition, this shift in regime could create a number of legal and accounting complexities with respect to existing relationships, including uncertainty regarding the continuity of contracts entered into by entities in the United Kingdom or the European Union. Our compliance with new or revised laws and regulations, or the interpretation and application of existing laws and regulations, could materially and adversely affect our product sales, financial condition, and results of operations. As a consequence of the legal and regulatory environment in which we operate, we are faced with a heightened risk of legal claims and regulatory enforcement actions.
As previously disclosed on February 21, 2019, we received a subpoena in October 2018 from the SEC related to our procurement area, specifically the accounting policies, procedures, and internal controls related to our procurement function, including, but not limited to, agreements, side agreements, and changes or modifications to agreements with our suppliers. Following the receipt of this subpoena, we, together with external counsel and forensic accountants, and subsequently, under the oversight of the Audit Committee, conducted an internal investigation into our procurement area and related matters. The SEC has issued additional subpoenas seeking information related to our financial reporting, internal controls, disclosures, our assessment of goodwill and intangible asset impairments, our communications with certain shareholders, and other procurement-related information and materials in connection with its investigation. The United States Attorney’s Office for the Northern District of Illinois (“USAO”) is also reviewing this matter. We and certain of our current and former officers and directors are currently defendants in a consolidated securities class action lawsuit, a class action lawsuit brought under the Employee Retirement Income Security Act (“ERISA”), a consolidated stockholder derivative action pending in federal court, and eight stockholder derivative actions pending in the Delaware Court of Chancery.
We are cooperating with the SEC and USAO, and intend to vigorously defend the civil lawsuits. We are unable, at this time, to estimate our potential liability in these matters. In connection with the securities and ERISA class action lawsuits and the stockholder derivative actions, we may be required to pay judgments, settlements, or other penalties and incur other costs and expenses. See Item 3, Legal Proceedings, and Note 17, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data, for additional information.
In connection with the SEC and USAO investigations, we could be required to pay significant civil or criminal penalties and become subject to injunctions, cease and desist orders, and other equitable remedies. The SEC and USAO investigations have not been resolved as of the filing of this Annual Report on Form 10-K. We can provide no assurances as to the outcome or timing of any governmental or regulatory investigation.
We have incurred, and may continue to incur, significant expenses related to legal, accounting, and other professional services in connection with the internal investigation, the SEC investigation, and related legal and regulatory matters. These expenses have adversely affected, and could continue to adversely affect, our business, financial condition, and cash flows.
As a result of matters associated with the internal investigation related to the SEC investigation and various lawsuits, we are exposed to greater risks associated with litigation, regulatory proceedings, and government enforcement actions and additional subpoenas. Any future investigations or additional lawsuits may have a material adverse effect on our business, financial condition, results of operations, and cash flows.
15
We identified material weaknesses in our internal control over financial reporting. If we are unable to remediate these material weaknesses, or if we experience additional material weaknesses or other deficiencies in the future or otherwise fail to maintain an effective system of internal controls, we may not be able to accurately and timely report our financial results, in which case our business may be harmed, investors may lose confidence in the accuracy and completeness of our financial reports, and the price of our common stock may decline.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on the effectiveness of our system of internal control. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). As a public company, we are required to comply with the Sarbanes-Oxley Act and other rules that govern public companies. In particular, we are required to certify our compliance with Section 404 of the Sarbanes-Oxley Act, which requires us to furnish annually a report by management on the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm is required to report on the effectiveness of our internal control over financial reporting.
Consistent with the prior year and in connection with our 2019 year-end assessment of internal control over financial reporting, we determined that, as of December 28, 2019, we did not maintain effective internal control over financial reporting because of a material weakness in our risk assessment process related to designing and maintaining controls sufficient to appropriately respond to changes in our business environment. This material weakness in risk assessment also contributed to a material weakness arising from supplier contracts and related arrangements, and we have taken and are taking certain remedial steps to improve our internal control over financial reporting. For further discussion of the material weaknesses identified and our remedial efforts, see Item 9A, Controls and Procedures.
Remediation efforts place a significant burden on management and add increased pressure to our financial resources and processes. As a result, we may not be successful in making the improvements necessary to remediate the material weaknesses identified by management, be able to do so in a timely manner, or be able to identify and remediate additional control deficiencies, including material weaknesses, in the future.
If we are unable to successfully remediate our existing or any future material weaknesses or other deficiencies in our internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected; our liquidity, our access to capital markets, the perceptions of our creditworthiness, and our ability to complete acquisitions may be adversely affected; we may be unable to maintain compliance with applicable securities laws, The Nasdaq Stock Market LLC (“Nasdaq”) listing requirements, and the covenants under our debt instruments or derivative arrangements regarding the timely filing of periodic reports; we may be subject to regulatory investigations and penalties; investors may lose confidence in our financial reporting; we may suffer defaults, accelerations, or cross-accelerations under our debt instruments or derivative arrangements to the extent we are unable to obtain waivers from the required creditors or counterparties or are unable to cure any breaches; and our stock price may decline.
Our failure to prepare and timely file our periodic reports with the SEC limits our access to the public markets to raise debt or equity capital.
We did not file our Annual Report on Form 10-K for the year ended December 29, 2018 or our Quarterly Report on Form 10-Q for the fiscal quarter ended March 30, 2019 within each respective timeframe required by the SEC, meaning we did not remain current in our reporting requirements with the SEC. As such, we are not currently eligible to use a registration statement on Form S-3 that would allow us to continuously incorporate by reference our SEC reports into the registration statement, or to use “shelf” registration statements to conduct offerings, until we have maintained our status as a current filer for approximately one year. This limits our ability to access the public markets to raise debt or equity capital, which could prevent us from pursuing transactions or implementing business strategies that we might otherwise believe are beneficial to our business. If we wish to pursue a public offering now, we would be required to file a registration statement on Form S-1 and have it reviewed and declared effective by the SEC. Doing so would likely take significantly longer than using a registration statement on Form S-3 and increase our transaction costs, and the necessity of using a Form S-1 for a public offering of registered securities could, to the extent we are not able to conduct offerings using alternative methods, adversely impact our ability to raise capital or complete acquisitions of other companies in a timely manner.
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We restated certain of our previously issued consolidated financial statements, which resulted in unanticipated costs and may affect investor confidence and raise reputational issues.
As discussed in the Explanatory Note, in Note 2, Restatement of Previously Issued Consolidated Financial Statements, and in Note 23, Quarterly Financial Data (Unaudited), in our Annual Report on Form 10-K for the year ended December 29, 2018, we restated our consolidated financial statements and related disclosures for the years ended December 30, 2017 and December 31, 2016 and restated each of the quarterly and year-to-date periods for the nine months ended September 29, 2018 and for fiscal year 2017, following the identification of misstatements as a result of the internal investigation conducted. We do not believe that the misstatements were quantitatively material to any period presented in our prior financial statements. However, due to the qualitative nature of the matters identified in our internal investigation, including the number of years over which the misconduct occurred and the number of transactions, suppliers, and procurement employees involved, we determined that it would be appropriate to correct the misstatements in our previously issued consolidated financial statements by restating such financial statements. The restatement also included corrections for additional identified out-of-period and uncorrected misstatements in the impacted periods. As a result, we incurred unanticipated costs for accounting and legal fees in connection with or related to the restatement, and have become subject to a number of additional risks and uncertainties, which may affect investor confidence in the accuracy of our financial disclosures and may raise reputational issues for our business.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products and brands.
We consider our intellectual property rights, particularly and most notably our trademarks, but also our patents, trade secrets, trade dress, copyrights, and licensing agreements, to be a significant and valuable aspect of our business. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright, trade secret, and trade dress laws, as well as licensing agreements, third-party nondisclosure and assignment agreements, and policing of third-party misuses of our intellectual property. Our failure to develop or adequately protect our trademarks, products, new features of our products, or our technology, or any change in law or other changes that serve to lessen or remove the current legal protections of our intellectual property, may diminish our competitiveness and could materially harm our business and financial condition. We also license certain intellectual property, most notably trademarks, from third parties. To the extent that we are not able to contract with these third parties on favorable terms or maintain our relationships with these third parties, our rights to use certain intellectual property could be impacted.
We may be unaware of intellectual property rights of others that may cover some of our technology, brands, or products. Any litigation regarding patents or other intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Third-party claims of intellectual property infringement might also require us to enter into costly license agreements. We also may be subject to significant damages or injunctions against development and sale of certain products.
Changes in tax laws and interpretations could adversely affect our business.
We are subject to income and other taxes in the United States and in numerous foreign jurisdictions. Our domestic and foreign tax liabilities are dependent on the jurisdictions in which profits are determined to be earned and taxed. Additionally, the amount of taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we operate. A number of factors influence our effective tax rate, including changes in tax laws and treaties as well as the interpretation of existing laws and rules. Federal, state, and local governments and administrative bodies within the United States, which represents the majority of our operations, and other foreign jurisdictions have implemented, or are considering, a variety of broad tax, trade, and other regulatory reforms that may impact us. For example, the Tax Cuts and Jobs Act (the “U.S. Tax Reform”) enacted on December 22, 2017 resulted in changes in our corporate tax rate, our deferred income taxes, and the taxation of foreign earnings. Relatedly, changes in tax laws resulting from the Organization for Economic Co-operation and Development’s (“OECD”) multi-jurisdictional plan of action to address base erosion and profit sharing (“BEPS”) could impact our effective tax rate. It is not currently possible to accurately determine the potential comprehensive impact of these or future changes, but these changes could have a material impact on our business and financial condition.
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Significant judgment, knowledge, and experience are required in determining our worldwide provision for income taxes. Our future effective tax rate is impacted by a number of factors including changes in the valuation of our deferred tax assets and liabilities, changes in geographic mix of income, increases in expenses not deductible for tax, including impairment of goodwill, and changes in available tax credits. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are also regularly subject to audits by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. Economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes more difficult. The results of an audit or litigation could adversely affect our financial statements in the period or periods for which that determination is made.
Registered Securities Risks
Sales of our common stock in the public market could cause volatility in the price of our common stock or cause the share price to fall.
Sales of a substantial number of shares of our common stock in the public market, sales of our common stock by the Sponsors, or the perception that these sales might occur, could depress the market price of our common stock, and could impair our ability to raise capital through the sale of additional equity securities. A sustained depression in the market price of our common stock has happened (which was a contributing factor to our decision to perform interim impairment tests for certain reporting units and brands in 2018 and 2019, for which we ultimately recorded impairment losses) and could in the future happen, which could also reduce our market capitalization below the book value of net assets, which could increase the likelihood of recognizing goodwill or indefinite-lived intangible asset impairment losses that could negatively affect our financial condition and results of operations.
Kraft Heinz, 3G Capital, and Berkshire Hathaway entered into a registration rights agreement requiring us to register for resale under the Securities Act all registrable shares held by 3G Capital and Berkshire Hathaway, which represents all shares of our common stock held by the Sponsors as of the date of the closing of the 2015 Merger. As of December 28, 2019, registrable shares represented approximately 47% of all outstanding shares of our common stock. Although the registrable shares are subject to certain holdback and suspension periods, the registrable shares are not subject to a “lock-up” or similar restriction under the registration rights agreement. Accordingly, offers and sales of a large number of registrable shares may be made pursuant to an effective registration statement under the Securities Act in accordance with the terms of the registration rights agreement. Sales of our common stock by the Sponsors to other persons would likely result in an increase in the number of shares being traded in the public market and may increase the volatility of the price of our common stock.
Our ability to pay regular dividends to our shareholders and the amounts of any such dividends are subject to the discretion of the Board of Directors and may be limited by our financial condition, debt agreements, or limitations under Delaware law.
Although it is currently anticipated that we will continue to pay regular quarterly dividends, any such determination to pay dividends and the amounts thereof will be at the discretion of the Board of Directors and will be dependent on then-existing conditions, including our financial condition, income, legal requirements, including limitations under Delaware law, debt agreements, and other factors the Board of Directors deems relevant. The Board of Directors has decided, and may in the future decide, in its sole discretion, to change the amount or frequency of dividends or discontinue the payment of dividends entirely. For these reasons, shareholders will not be able to rely on dividends to receive a return on investment. Accordingly, realization of any gain on shares of our common stock may depend on the appreciation of the price of our common stock, which may never occur.
Volatility of capital markets or macroeconomic factors could adversely affect our business.
Changes in financial and capital markets, including market disruptions, limited liquidity, uncertainty regarding Brexit in the transition period and beyond, and interest rate volatility, may increase the cost of financing as well as the risks of refinancing maturing debt. Our U.S. dollar variable rate debt uses LIBOR as a benchmark for determining interest rates and the Financial Conduct Authority in the United Kingdom intends to phase out LIBOR by the end of 2021. While we do not expect that the transition from LIBOR, including any legal or regulatory changes made in response to its future phase out, or the risks related to its discontinuance will have a material effect on our financing costs, the impact is uncertain at this time.
Some of our customers and counterparties are highly leveraged. Consolidations in some of the industries in which our customers operate have created larger customers, some of which are highly leveraged and facing increased competition and continued credit market volatility. These factors have caused some customers to be less profitable, increasing our exposure to credit risk. A significant adverse change in the financial and/or credit position of a customer or counterparty could require us to assume greater credit risk relating to that customer or counterparty and could limit our ability to collect receivables. This could have an adverse impact on our financial condition and liquidity.
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A downgrade in our credit rating could adversely impact interest costs or access to future borrowings.
Our borrowing costs can be affected by short and long-term credit ratings assigned by rating organizations. A decrease in these credit ratings could limit our access to capital markets and increase our borrowing costs, which could materially and adversely affect our financial condition and operating results. On February 14, 2020, Moody’s Investor Services, Inc. (“Moody’s”) affirmed our long-term credit rating of Baa3 with a negative outlook and Fitch Ratings (“Fitch”) and S&P Global Ratings (“S&P”) downgraded our long-term credit rating from BBB- to BB+ with a stable outlook from Fitch and a negative outlook from S&P. The downgrades by Fitch and S&P reduce our senior debt below investment grade, potentially resulting in higher borrowing costs on future financings and potentially limiting access to our commercial paper program and other sources of funding which may result in us having to use more expensive sources of liquidity, such as our Senior Credit Facility. These downgrades do not constitute a default or event of default under our debt instruments. However, as two ratings agencies have downgraded our long-term credit rating to below investment grade status, we are subject to certain financial covenants in our 4.875% Second Lien Senior Secured Notes due February 15, 2025 (the “2025 Notes”).
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our corporate co-headquarters are located in Pittsburgh, Pennsylvania and Chicago, Illinois. Our co-headquarters are leased and house certain executive offices, our U.S. business units, and our administrative, finance, legal, and human resource functions. We maintain additional owned and leased offices throughout the regions in which we operate.
We manufacture our products in our network of manufacturing and processing facilities located throughout the world. As of December 28, 2019, we operated 83 manufacturing and processing facilities. We own 80 and lease three of these facilities. Our manufacturing and processing facilities count by segment as of December 28, 2019 was:
Owned | Leased | ||
United States | 40 | 1 | |
Canada | 1 | 1 | |
EMEA | 13 | — | |
Rest of World | 26 | 1 |
We maintain all of our manufacturing and processing facilities in good condition and believe they are suitable and are adequate for our present needs. We also enter into co-manufacturing arrangements with third parties if we determine it is advantageous to outsource the production of any of our products.
In 2019, we divested certain assets and operations, predominantly in Canada and India, including one owned manufacturing facility in Canada and one owned and one leased facility in India. See Note 4, Acquisitions and Divestitures, in Item 8, Financial Statements and Supplementary Data, for additional information on these transactions.
Item 3. Legal Proceedings.
See Note 17, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is listed on Nasdaq under the ticker symbol “KHC”. At February 8, 2020, there were approximately 47,000 holders of record of our common stock.
See Equity and Dividends in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for a discussion of cash dividends declared on our common stock.
Comparison of Cumulative Total Return
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The following graph compares the cumulative total return on our common stock with the cumulative total return of the Standard & Poor's (“S&P”) 500 Index and the S&P Consumer Staples Food and Soft Drink Products, which we consider to be our peer group. Companies included in the S&P Consumer Staples Food and Soft Drink Products index change periodically and are presented on the basis of the index as it is comprised on December 28, 2019. This graph covers the period from July 6, 2015 (the first day our common stock began trading on Nasdaq) through December 27, 2019 (the last trading day of our fiscal year 2019). The graph shows total shareholder return assuming $100 was invested on July 6, 2015 and the dividends were reinvested on a daily basis.

Kraft Heinz | S&P 500 | S&P Consumer Staples Food and Soft Drink Products | |||||||||
July 6, 2015 | $ | 100.00 | $ | 100.00 | $ | 100.00 | |||||
December 31, 2015 | 102.07 | 99.85 | 110.18 | ||||||||
December 30, 2016 | 125.99 | 111.79 | 114.98 | ||||||||
December 29, 2017 | 115.44 | 136.20 | 128.53 | ||||||||
December 28, 2018 | 67.49 | 129.11 | 121.93 | ||||||||
December 27, 2019 | 51.78 | 171.50 | 157.80 |
The above performance graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act.
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Issuer Purchases of Equity Securities During the Three Months Ended December 28, 2019
Our share repurchase activity in the three months ended December 28, 2019 was:
Total Number of Shares Purchased(a) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(b) | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||||
9/29/2019 - 11/2/2019 | 15,166 | $ | 27.84 | — | $ | — | ||||||||
11/3/2019 - 11/30/2019 | 128,625 | 32.19 | — | — | ||||||||||
12/1/2019 - 12/28/2019 | 43,491 | 31.48 | — | — | ||||||||||
Total | 187,282 | — |
(a) | Includes the following types of share repurchase activity, when they occur: (1) shares repurchased in connection with the exercise of stock options (including periodic repurchases using option exercise proceeds), (2) shares withheld for tax liabilities associated with the vesting of restricted stock units, and (3) shares repurchased related to employee benefit programs (including our annual bonus swap program) or to offset the dilutive effect of equity issuances. |
(b) | We do not have any publicly announced share repurchase plans or programs. |
Item 6. Selected Financial Data.
The following table presents selected consolidated financial data for the last five fiscal years. Our fiscal years 2019, 2018, 2017, and 2016 include a full year of Kraft Heinz results. Our fiscal year 2015 includes a full year of Heinz results and post-merger Kraft results.
(Unaudited) | |||||||||||||||||||
December 28, 2019 (52 weeks) | December 29, 2018 (52 weeks) | December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks)(g) | January 3, 2016 (53 weeks) | |||||||||||||||
(in millions, except per share data) | |||||||||||||||||||
Period Ended: | |||||||||||||||||||
Net sales(a) | $ | 24,977 | $ | 26,268 | $ | 26,076 | $ | 26,300 | $ | 18,318 | |||||||||
Income/(loss)(b)(c)(d) | 1,933 | (10,254 | ) | 10,932 | 3,606 | 614 | |||||||||||||
Income/(loss) attributable to common shareholders(b)(c)(d) | $ | 1,935 | (10,192 | ) | 10,941 | 3,416 | (299 | ) | |||||||||||
Income/(loss) per common share: | |||||||||||||||||||
Basic(b)(c)(d) | $ | 1.59 | (8.36 | ) | 8.98 | 2.81 | (0.38 | ) | |||||||||||
Diluted(b)(c)(d) | 1.58 | (8.36 | ) | 8.91 | 2.78 | (0.38 | ) | ||||||||||||
(Unaudited) | |||||||||||||||||||
December 28, 2019 | December 29, 2018 | December 30, 2017 | December 31, 2016 | January 3, 2016 | |||||||||||||||
(in millions, except per share data) | |||||||||||||||||||
As of: | |||||||||||||||||||
Total assets(c) | 101,450 | 103,461 | 120,092 | 120,617 | 123,110 | ||||||||||||||
Long-term debt(e) | 28,216 | 30,770 | 28,308 | 29,712 | 25,148 | ||||||||||||||
Redeemable preferred stock(f) | — | — | — | — | 8,320 | ||||||||||||||
Cash dividends per common share | 1.60 | 2.50 | 2.45 | 2.35 | 1.70 |
(a) | The increase in net sales in 2016 compared to the prior year was primarily driven by the 2015 Merger. |
(b) | The increases in income/(loss), income/(loss) attributable to common shareholders, and basic and diluted income/(loss) per common share in 2017 compared to 2016 were primarily driven by U.S. Tax Reform, which was enacted in December 2017. See Note 10, Income Taxes, in Item 8, Financial Statements and Supplementary Data, for additional information. |
(c) | The decreases in income/(loss), income/(loss) attributable to common shareholders, and basic and diluted income/(loss) per common share in 2018 compared to 2017, and the decrease in total assets from December 30, 2017 to December 29, 2018, were primarily driven by non-cash impairment losses in 2018. See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information. |
(d) | The increases in income/(loss), income/(loss) attributable to common shareholders, and basic and diluted income/(loss) per common share in 2019 compared to 2018, were primarily driven by higher non-cash impairment losses in 2018. See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information. |
(e) | Amounts exclude the current portion of long-term debt. |
(f) | On June 7, 2016, we redeemed all outstanding shares of our 9.00% cumulative compounding preferred stock, Series A. See Equity and Dividends in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, along with Note 19, Debt, and Note 20, Capital Stock, in Item 8, Financial Statements and Supplementary Data, in our Annual Report on Form 10-K for the year ended December 29, 2018 for additional information. |
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(g) | On December 9, 2016, our Board of Directors approved a change to our fiscal year end from Sunday to Saturday. Effective December 31, 2016, we operate on a 52- or 53-week fiscal year ending on the last Saturday in December in each calendar year. In prior years, we operated on a 52- or 53-week fiscal year ending the Sunday closest to December 31. As a result, we occasionally have a 53rd week in a fiscal year. Our 2015 fiscal year includes a 53rd week of activity. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
Description of the Company:
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 EMEA. Our remaining businesses are combined and disclosed as “Rest of World.” Rest of World comprises two operating segments: Latin America and APAC.
During the third quarter of 2019, certain organizational changes were announced that will impact our future internal reporting and reportable segments. As a result of these changes, we plan to combine our EMEA, Latin America, and APAC zones to form the International zone. The International zone will be a reportable segment along with the United States and Canada in 2020. We also plan to move our Puerto Rico business from the Latin America zone to the United States zone to consolidate and streamline the management of our product categories and supply chain. These changes will be effective in the first quarter of 2020.
See Note 22, Segment Reporting, in Item 8, Financial Statements and Supplementary Data, to the consolidated financial statements for our financial information by segment.
See below for discussion and analysis of our financial condition and results of operations for 2019 compared to 2018. See Item 7, Management’s Discussions and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 29, 2018 for a detailed discussion of our financial condition and results of operations for 2018 compared to 2017.
Items Affecting Comparability of Financial Results
Impairment Losses:
Our 2019 results of operations reflect goodwill impairment losses of $1.2 billion and intangible asset impairment losses of $702 million compared to goodwill impairment losses of $7.0 billion and intangible asset impairment losses of $8.9 billion in 2018. See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information on these impairment losses.
Results of Operations
We disclose in this report certain non-GAAP financial measures. These non-GAAP financial measures assist 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 underlying operations. For additional information and reconciliations from our consolidated financial statements see Non-GAAP Financial Measures.
Consolidated Results of Operations
Summary of Results:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions, except per share data) | ||||||||||
Net sales | $ | 24,977 | $ | 26,268 | (4.9 | )% | ||||
Operating income/(loss) | 3,070 | (10,205 | ) | 130.1 | % | |||||
Net income/(loss) attributable to common shareholders | 1,935 | (10,192 | ) | 119.0 | % | |||||
Diluted EPS | 1.58 | (8.36 | ) | 118.9 | % |
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Net Sales:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Net sales | $ | 24,977 | $ | 26,268 | (4.9 | )% | ||||
Organic Net Sales(a) | 24,961 | 25,393 | (1.7 | )% |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Net sales decreased 4.9% to $25.0 billion in 2019 compared to $26.3 billion in 2018 primarily due to the unfavorable impacts of foreign currency (1.9 pp) and acquisitions and divestitures (1.3 pp). Organic Net Sales decreased 1.7% to $25.0 billion in 2019 compared to $25.4 billion in 2018 due to unfavorable volume/mix (1.8 pp), partially offset by higher pricing (0.1 pp). Volume/mix was unfavorable in the United States, Rest of World, and EMEA, which was partially offset by growth in Canada. Higher pricing in the United States and Rest of World was partially offset by lower pricing in Canada, while pricing in EMEA was flat.
Net Income/(Loss):
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Operating income/(loss) | $ | 3,070 | $ | (10,205 | ) | 130.1 | % | |||
Net income/(loss) attributable to common shareholders | 1,935 | (10,192 | ) | 119.0 | % | |||||
Adjusted EBITDA(a) | 6,064 | 7,024 | (13.7 | )% |
(a) | Adjusted EBITDA is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Operating income/(loss) increased 130.1% to income of $3.1 billion in 2019 compared to a loss of $10.2 billion in 2018. This increase was primarily driven by lower impairment losses in the current year. Impairment losses were $1.9 billion in 2019 compared to $15.9 billion in 2018. Excluding the impact of these impairment losses, operating income/(loss) decreased by $762 million primarily due to lower Organic Net Sales, higher supply chain costs, the unfavorable impact of foreign currency (0.8 pp), higher general corporate expenses, and the unfavorable impact of divestitures, partially offset by lower restructuring expenses in the current period. See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information on our impairment losses.
Net income/(loss) attributable to common shareholders increased 119.0% to income of $1.9 billion in 2019 compared to a loss of $10.2 billion in 2018. This change was driven by the operating income/(loss) factors described above (primarily lower impairment losses in 2019 compared to 2018) and favorable impacts in other expense/(income), partially offset by a higher effective tax rate and higher interest expense, detailed as follows.
• | Other expense/(income) was $952 million of income in 2019 compared to $168 million of income in 2018. This increase was primarily driven by a $420 million net gain on sales of businesses in 2019 compared to a $15 million loss on sale of our South Africa subsidiary in 2018, a $162 million non-cash settlement charge in the prior year related to the wind-up of our Canadian salaried and Canadian hourly defined benefit pension plans, and a $136 million decrease in nonmonetary currency devaluation losses related to our Venezuelan operations as compared to the prior year period. The $420 million net gain on sales of businesses in 2019 consisted of a $249 million gain on the sale of Heinz India Private Limited (“Heinz India”) (“Heinz India Transaction”), a $242 million gain on the sale of certain assets in our natural cheese business in Canada (“Canada Natural Cheese Transaction”), and a $71 million loss on an anticipated sale of a subsidiary within our Rest of World segment. |
• | The effective tax rate was 27.4% in 2019 on pre-tax income compared to 9.4% in 2018 on a pre-tax loss. The 2019 effective tax rate was higher primarily driven by lower non-deductible goodwill impairments, partially offset by a more favorable geographic mix of pre-tax income in various non-U.S. jurisdictions and a decrease in unfavorable rate reconciling items. Current year unfavorable impacts primarily related to non-deductible goodwill impairments, the impact of the federal tax on global intangible low-taxed income (“GILTI”), an increase in uncertain tax position reserves, the establishment of certain state valuation allowance reserves, and the tax impacts from the Heinz India and Canada Natural Cheese Transactions. These impacts were partially offset by the reversal of certain withholding tax obligations and changes in estimates of certain 2018 U.S. income and deductions. |
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• | Interest expense was $1.4 billion in 2019 compared to $1.3 billion in 2018. This increase was primarily driven by a $98 million loss on extinguishment of debt recognized in connection with our debt tender offers and redemptions completed in 2019. Excluding the impact of the loss on extinguishment of debt, interest expense was generally flat as compared to the prior year period. |
Adjusted EBITDA decreased 13.7% to $6.1 billion in 2019 compared to $7.0 billion in 2018. This decrease was primarily due to lower Organic Net Sales, higher supply chain costs, the unfavorable impact of foreign currency (2.8 pp), higher general corporate expenses, and the unfavorable impact of divestitures.
Diluted EPS:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions, except per share data) | ||||||||||
Diluted EPS | $ | 1.58 | $ | (8.36 | ) | 118.9 | % | |||
Adjusted EPS(a) | 2.85 | 3.51 | (18.8 | )% |
(a) | Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Diluted EPS increased 118.9% to earnings of $1.58 in 2019 compared to a loss of $8.36 in 2018 primarily driven by the net income/(loss) attributable to common shareholders factors discussed above.
December 28, 2019 | December 29, 2018 | $ Change | % Change | |||||||||||
Diluted EPS | $ | 1.58 | $ | (8.36 | ) | $ | 9.94 | 118.9 | % | |||||
Integration and restructuring expenses | 0.07 | 0.32 | (0.25 | ) | ||||||||||
Deal costs | 0.02 | 0.02 | — | |||||||||||
Unrealized losses/(gains) on commodity hedges | (0.04 | ) | 0.01 | (0.05 | ) | |||||||||
Impairment losses | 1.38 | 11.28 | (9.90 | ) | ||||||||||
Losses/(gains) on sale of business | (0.23 | ) | 0.01 | (0.24 | ) | |||||||||
Other losses/(gains) related to acquisitions and divestitures | — | 0.02 | (0.02 | ) | ||||||||||
Nonmonetary currency devaluation | 0.01 | 0.12 | (0.11 | ) | ||||||||||
Debt prepayment and extinguishment costs | 0.06 | — | 0.06 | |||||||||||
U.S. Tax Reform discrete income tax expense/(benefit) | — | 0.09 | (0.09 | ) | ||||||||||
Adjusted EPS(a) | $ | 2.85 | $ | 3.51 | $ | (0.66 | ) | (18.8 | )% | |||||
Key drivers of change in Adjusted EPS(a): | ||||||||||||||
Results of operations | $ | (0.64 | ) | |||||||||||
Results of divested operations | (0.05 | ) | ||||||||||||
Interest expense | 0.01 | |||||||||||||
Other expense/(income) | 0.02 | |||||||||||||
$ | (0.66 | ) |
(a) | Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Adjusted EPS decreased 18.8% to $2.85 in 2019 compared to $3.51 in 2018 primarily due to lower Adjusted EBITDA and higher depreciation and amortization expenses, partially offset by favorable changes in other expense/(income) and lower interest expense.
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Results of Operations by Segment
Management evaluates segment performance based on several factors, including net sales, Organic Net Sales, and Segment Adjusted EBITDA. Segment Adjusted EBITDA is defined as net income/(loss) from continuing operations before interest expense, other expense/(income), provision for/(benefit from) income taxes, and depreciation and amortization (excluding integration and restructuring expenses); in addition to these adjustments, we exclude, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized gains/(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, and equity award compensation expense (excluding integration and restructuring expenses). Segment Adjusted EBITDA is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Under highly inflationary accounting, the financial statements of a subsidiary are remeasured into our reporting currency (U.S. dollars) based on the legally available exchange rate at which we expect to settle the underlying transactions. Exchange gains and losses from the remeasurement of monetary assets and liabilities are reflected in net income/(loss), rather than accumulated other comprehensive income/(losses) on the balance sheet, until such time as the economy is no longer considered highly inflationary. The exchange gains and losses from remeasurement are recorded in current net income/(loss) and are classified within other expense/(income), as nonmonetary currency devaluation. See Note 15, Venezuela - Foreign Currency and Inflation, and Note 2, Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data, for additional information.
Net Sales:
December 28, 2019 | December 29, 2018 | ||||||
(in millions) | |||||||
Net sales: | |||||||
United States | $ | 17,756 | $ | 18,122 | |||
Canada | 1,882 | 2,173 | |||||
EMEA | 2,551 | 2,718 | |||||
Rest of World | 2,788 | 3,255 | |||||
Total net sales | $ | 24,977 | $ | 26,268 |
Organic Net Sales:
December 28, 2019 | December 29, 2018 | ||||||
(in millions) | |||||||
Organic Net Sales(a): | |||||||
United States | $ | 17,756 | $ | 18,122 | |||
Canada | 1,700 | 1,732 | |||||
EMEA | 2,666 | 2,697 | |||||
Rest of World | 2,839 | 2,842 | |||||
Total Organic Net Sales | $ | 24,961 | $ | 25,393 |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Drivers of the changes in net sales and Organic Net Sales were:
Net Sales | Currency | Acquisitions and Divestitures | Organic Net Sales | Price | Volume/Mix | ||||||||
2019 Compared to 2018 | |||||||||||||
United States | (2.0 | )% | 0.0 pp | 0.0 pp | (2.0 | )% | 0.4 pp | (2.4) pp | |||||
Canada | (13.4 | )% | (2.1) pp | (9.4) pp | (1.9 | )% | (3.4) pp | 1.5 pp | |||||
EMEA | (6.2 | )% | (4.3) pp | (0.7) pp | (1.2 | )% | 0.0 pp | (1.2) pp | |||||
Rest of World | (14.3 | )% | (10.3) pp | (3.9) pp | (0.1 | )% | 1.2 pp | (1.3) pp | |||||
Kraft Heinz | (4.9 | )% | (1.9) pp | (1.3) pp | (1.7 | )% | 0.1 pp | (1.8) pp |
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Adjusted EBITDA:
December 28, 2019 | December 29, 2018 | ||||||
(in millions) | |||||||
Segment Adjusted EBITDA: | |||||||
United States | $ | 4,809 | $ | 5,218 | |||
Canada | 487 | 608 | |||||
EMEA | 661 | 724 | |||||
Rest of World | 363 | 635 | |||||
General corporate expenses | (256 | ) | (161 | ) | |||
Depreciation and amortization (excluding integration and restructuring expenses) | (985 | ) | (919 | ) | |||
Integration and restructuring expenses | (102 | ) | (297 | ) | |||
Deal costs | (19 | ) | (23 | ) | |||
Unrealized gains/(losses) on commodity hedges | 57 | (21 | ) | ||||
Impairment losses | (1,899 | ) | (15,936 | ) | |||
Equity award compensation expense (excluding integration and restructuring expenses) | (46 | ) | (33 | ) | |||
Operating income | 3,070 | (10,205 | ) | ||||
Interest expense | 1,361 | 1,284 | |||||
Other expense/(income) | (952 | ) | (168 | ) | |||
Income/(loss) before income taxes | $ | 2,661 | $ | (11,321 | ) |
United States:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Net sales | $ | 17,756 | $ | 18,122 | (2.0 | )% | ||||
Organic Net Sales(a) | 17,756 | 18,122 | (2.0 | )% | ||||||
Segment Adjusted EBITDA | 4,809 | 5,218 | (7.8 | )% |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Net sales and Organic Net Sales both decreased 2.0% to $17.8 billion in 2019 compared to $18.1 billion in 2018. This decrease was primarily due to unfavorable volume/mix (2.4 pp), partially offset by higher pricing (0.4 pp). Unfavorable volume/mix was primarily due to unfavorable changes in retail inventory levels versus the prior year and lower shipments in meat, cheese, and coffee, partially offset by growth in nuts as well as condiments and sauces. Higher pricing was primarily driven by price increases to reflect higher key-commodity costs for meat and cheese, which more than offset lower key-commodity driven pricing on coffee and nuts.
Segment Adjusted EBITDA decreased 7.8% to $4.8 billion in 2019 compared to $5.2 billion in 2018. This decrease was primarily due to lower Organic Net Sales, cost inflation in procurement and manufacturing, strategic investments, and supply chain losses.
Canada:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Net sales | $ | 1,882 | $ | 2,173 | (13.4 | )% | ||||
Organic Net Sales(a) | 1,700 | 1,732 | (1.9 | )% | ||||||
Segment Adjusted EBITDA | 487 | 608 | (19.9 | )% |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
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Fiscal Year 2019 Compared to Fiscal Year 2018:
Net sales decreased 13.4% to $1.9 billion in 2019 compared to $2.2 billion in 2018 primarily due to the unfavorable impacts of acquisitions and divestitures (9.4 pp) and foreign currency (2.1 pp). Organic Net Sales decreased 1.9% to $1.7 billion in 2019 compared to $1.7 billion in 2018 due to lower pricing (3.4 pp), partially offset by favorable volume/mix (1.5 pp). Pricing was lower across categories, primarily due to higher promotional costs versus the prior year, particularly in condiments and sauces and cheese. Favorable volume/mix was primarily driven by growth in condiments and sauces, spreads, and cheese.
Segment Adjusted EBITDA decreased 19.9% to $487 million in 2019 compared to $608 million in 2018 partially due to the unfavorable impact of foreign currency (1.9 pp). Excluding the currency impact, Segment Adjusted EBITDA decreased primarily due to lower Organic Net Sales, the Canada Natural Cheese Transaction which closed on July 2, 2019, and higher input costs.
EMEA:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Net sales | $ | 2,551 | $ | 2,718 | (6.2 | )% | ||||
Organic Net Sales(a) | 2,666 | 2,697 | (1.2 | )% | ||||||
Segment Adjusted EBITDA | 661 | 724 | (8.7 | )% |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Net sales decreased 6.2% to $2.6 billion in 2019 compared to $2.7 billion in 2018 driven by the unfavorable impacts of foreign currency (4.3 pp) and acquisitions and divestitures (0.7 pp). Organic Net Sales decreased 1.2% to $2.7 billion in 2019 compared to $2.7 billion in 2018 due to unfavorable volume/mix (1.2 pp) while pricing was flat versus 2018. Unfavorable volume/mix was primarily due to the adverse impact of extended negotiations with key retailers, lower shipments of meals, and ongoing weakness in infant nutrition, partially offset by foodservice growth. Pricing was flat primarily due to lower pricing in infant nutrition, partially offset by price increases in meals.
Segment Adjusted EBITDA decreased 8.7% to $661 million in 2019 compared to $724 million in 2018, including the unfavorable impact of foreign currency (4.2 pp). Excluding the currency impact, the decrease was primarily due to higher supply chain costs in the current year and the benefit from the postemployment benefits accounting change in the prior year.
Rest of World:
December 28, 2019 | December 29, 2018 | % Change | ||||||||
(in millions) | ||||||||||
Net sales | $ | 2,788 | $ | 3,255 | (14.3 | )% | ||||
Organic Net Sales(a) | 2,839 | 2,842 | (0.1 | )% | ||||||
Segment Adjusted EBITDA | 363 | 635 | (42.8 | )% |
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Fiscal Year 2019 Compared to Fiscal Year 2018:
Net sales decreased 14.3% to $2.8 billion in 2019 compared to $3.3 billion in 2018 due to the unfavorable impact of foreign currency (10.3 pp, including 6.9 pp from the devaluation of the Venezuelan bolivar) and the unfavorable impact of acquisitions and divestitures (3.9 pp). Organic Net Sales decreased 0.1% to $2.8 billion in 2019 compared to $2.8 billion in 2018 primarily due to unfavorable volume/mix (1.3 pp), partially offset by higher pricing (1.2 pp). Unfavorable volume/mix was due to ongoing weakness in infant nutrition, partially offset by growth in condiments and sauces. Higher pricing was primarily driven by price increases in Brazil and Mexico.
Segment Adjusted EBITDA decreased 42.8% to $363 million in 2019 compared to $635 million in 2018, including the unfavorable impact of foreign currency (22.6 pp, including 20.8 pp from the devaluation of the Venezuelan bolivar) and costs not expected to repeat, from a combination of higher labor-related expenses from the impact of the Holidays Act in New Zealand, as well as asset- and inventory-related write-offs in Australia, New Zealand, and Latin America. Excluding these factors, the decrease in Segment Adjusted EBITDA was primarily due to higher supply chain costs and the Heinz India Transaction which closed on January 30, 2019.
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Critical Accounting Estimates
Note 2, Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data, includes a summary of the significant accounting policies we used to prepare our consolidated financial statements. The following is a review of the more significant assumptions and estimates as well as accounting policies we used to prepare our consolidated financial statements.
Revenue Recognition:
Our revenues are primarily derived from customer orders for the purchase of our products. We recognize revenues as performance obligations are fulfilled when control passes to our customers. We record revenues net of variable consideration, including consumer incentives and performance obligations related to trade promotions, excluding taxes, and including all shipping and handling charges billed to customers (accounting for shipping and handling charges that occur after the transfer of control as fulfillment costs). We also record a refund liability for estimated product returns and customer allowances as reductions to revenues within the same period that the revenue is recognized. We base these estimates principally on historical and current period experience factors. We recognize costs paid to third party brokers to obtain contracts as expenses as our contracts are generally less than one year.
Advertising, Consumer Incentives, and Trade Promotions:
We promote our products with advertising, consumer incentives, and performance obligations related to trade promotions. Consumer incentives and trade promotions include, but are not limited to, discounts, coupons, rebates, performance-based in-store display activities, and volume-based incentives. Variable consideration related to consumer incentive and trade promotion activities is recorded as a reduction to revenues based on amounts estimated as being due to customers and consumers at the end of a period. We base these estimates principally on historical utilization, redemption rates, and/or current period experience factors. We review and adjust these estimates at least quarterly based on actual experience and other information.
Advertising expenses are recorded in selling, general and administrative expenses (“SG&A”). For interim reporting purposes, we charge advertising to operations as a percentage of estimated full year sales activity and marketing costs. We then review and adjust these estimates each quarter based on actual experience and other information. We recorded advertising expenses of $534 million in 2019, $584 million in 2018, and $629 million in 2017, which represented costs to obtain physical advertisement spots in television, radio, print, digital, and social channels. We also incur other advertising and marketing costs such as shopper marketing, sponsorships, and agency advertisement conception, design, and public relations fees. Total advertising and marketing costs were $1.1 billion in 2019, 2018, and 2017.
Goodwill and Intangible Assets:
We maintain 19 reporting units, 11 of which comprise our goodwill balance. These 11 reporting units had an aggregate carrying amount of $35.5 billion as of December 28, 2019. Our indefinite-lived intangible asset balance primarily consists of a number of individual brands, which had an aggregate carrying amount of $43.4 billion as of December 28, 2019.
We test our reporting units and brands for impairment annually as of the first day of our second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit or brand is less than its carrying amount. Such events and circumstances could include a sustained decrease in our market capitalization, increased competition or unexpected loss of market share, increased input costs beyond projections (for example due to regulatory or industry changes), disposals of significant brands or components of our business, unexpected business disruptions (for example due to a natural disaster or loss of a customer, supplier, or other significant business relationship), unexpected significant declines in operating results, significant adverse changes in the markets in which we operate, or changes in management strategy. We test reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. We test brands for impairment by comparing the estimated fair value of each brand with its carrying amount. If the carrying amount of a reporting unit or brand exceeds its estimated fair value, we record an impairment loss based on the difference between fair value and carrying amount, in the case of reporting units, not to exceed the associated carrying amount of goodwill.
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Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units and brands requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax considerations, discount rates, growth rates, royalty rates, contributory asset charges, and other market factors. If current expectations of future growth rates and margins are not met, if market factors outside of our control, such as discount rates, change, or if management’s expectations or plans otherwise change, including as a result of updates to our global five-year operating plan, then one or more of our reporting units or brands might become impaired in the future. We are currently actively reviewing the enterprise strategy for the Company. As part of this strategic review, we expect to develop updates to the five-year operating plan in 2020, which could impact the allocation of investments among reporting units and brands and impact growth expectations and fair value estimates. Additionally, as a result of this strategic review process, we could decide to divest certain non-strategic assets. As a result, the ongoing development of the enterprise strategy and underlying detailed business plans could lead to the impairment of one or more of our reporting units or brands in the future, or a decision to amortize indefinite-lived intangible assets over a defined period of time.
As detailed in Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, we recorded impairment losses related to goodwill and indefinite-lived intangible assets in the current year and in the prior year. Our reporting units and brands that were impaired in 2018 and 2019 were written down to their respective fair values resulting in zero excess fair value over carrying amount as of the applicable impairment test dates. Accordingly, these and other individual reporting units and brands that have 20% or less excess fair value over carrying amount as of their latest 2019 impairment testing date have a heightened risk of future impairments if any assumptions, estimates, or market factors change in the future. Reporting units with 10% or less fair value over carrying amount had an aggregate goodwill carrying amount of $32.4 billion as of their latest 2019 impairment testing date and included U.S. Grocery, U.S. Refrigerated, U.S. Foodservice, Canada Retail, Canada Foodservice, Latin America Exports, and EMEA East. Reporting units with between 10-20% fair value over carrying amount had an aggregate goodwill carrying amount of $676 million as of their latest 2019 impairment testing date and included Continental Europe and Northeast Asia. The aggregate goodwill carrying amount of reporting units with fair value over carrying amount between 20-50% was $2.4 billion and there were no reporting units with fair value over carrying amount in excess of 50% as of their latest 2019 impairment testing date. Brands with 10% or less fair value over carrying amount had an aggregate carrying amount after impairment of $26.2 billion as of their latest 2019 impairment testing date and included: Kraft, Philadelphia, Velveeta, Lunchables, Miracle Whip, Planters, Maxwell House, Cool Whip, and ABC. Brands with between 10-20% fair value over carrying amount had an aggregate carrying amount of $3.7 billion as of their latest 2019 impairment testing date and included Oscar Mayer, Jet Puffed, Wattie’s, and Quero. The aggregate carrying amount of brands with fair value over carrying amount between 20-50% was $4.2 billion as of their latest 2019 impairment testing date. Although the remaining brands, with a carrying value of $9.2 billion, have more than 50% excess fair value over carrying amount as of their latest 2019 impairment testing date, these amounts are also associated with the 2013 Heinz acquisition and the 2015 Merger and are recorded on the balance sheet at their estimated acquisition date fair values. Therefore, if any estimates, market factors, or assumptions, including those related to our enterprise strategy or business plans, change in the future, these amounts are also susceptible to impairments.
We generally utilize the discounted cash flow method under the income approach to estimate the fair value of our reporting units. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each reporting unit (including net sales, cost of products sold, SG&A, depreciation and amortization, working capital, and capital expenditures), income tax rates, long-term growth rates, and a discount rate that appropriately reflects the risks inherent in each future cash flow stream. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
We utilize the excess earnings method under the income approach to estimate the fair value of certain of our largest brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each brand (including net sales, cost of products sold, and SG&A), contributory asset charges, income tax considerations, long-term growth rates, a discount rate that reflects the level of risk associated with the future earnings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
We utilize the relief from royalty method under the income approach to estimate the fair value of our remaining brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net sales for each brand, royalty rates (as a percentage of net sales that would hypothetically be charged by a licensor of the brand to an unrelated licensee), income tax considerations, long-term growth rates, a discount rate that reflects the level of risk associated with the future cost savings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
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The discount rates, long-term growth rates, and royalty rates used to estimate the fair values of our reporting units and brands with 10% or less excess fair value over carrying amount, as well as the goodwill or brand carrying amounts, as of the latest 2019 impairment testing date for each reporting unit or brand, were as follows:
Goodwill or Brand Carrying Amount (in billions) | Discount Rate | Long-Term Growth Rate | Royalty Rate | ||||||||||||||||||
Minimum | Maximum | Minimum | Maximum | Minimum | Maximum | ||||||||||||||||
Reporting units | $ | 32.4 | 6.8 | % | 10.3 | % | 1.0 | % | 4.0 | % | |||||||||||
Brands (excess earnings method) | 19.4 | 7.7 | % | 7.8 | % | 0.8 | % | 2.0 | % | ||||||||||||
Brands (relief from royalty method) | 6.8 | 7.0 | % | 10.7 | % | 0.5 | % | 3.5 | % | 7.0 | % | 20.0 | % |
The discount rates, long-term growth rates, and royalty rates used to estimate the fair values of our reporting units and brands with between 10-20% excess fair value over carry amount, as well as the goodwill or brand carrying amounts, as of the latest 2019 impairment testing date for each reporting unit or brand, were as follows:
Goodwill or Brand Carrying Amount (in billions) | Discount Rate | Long-Term Growth Rate | Royalty Rate | ||||||||||||||||||
Minimum | Maximum | Minimum | Maximum | Minimum | Maximum | ||||||||||||||||
Reporting units | $ | 0.7 | 6.5 | % | 11.3 | % | 2.5 | % | 3.5 | % | |||||||||||
Brands (excess earnings method) | 3.3 | 7.8 | % | 7.8 | % | 1.0 | % | 1.0 | % | ||||||||||||
Brands (relief from royalty method) | 0.4 | 7.6 | % | 10.3 | % | 1.3 | % | 4.0 | % | 1.0 | % | 17.0 | % |
Assumptions used in impairment testing are made at a point in time and require significant judgment; therefore, they are subject to change based on the facts and circumstances present at each annual and interim impairment test date. Additionally, these assumptions are generally interdependent and do not change in isolation. However, as it is reasonably possible that changes in assumptions could occur, as a sensitivity measure, we have presented the estimated effects of isolated changes in discount rates, long-term growth rates, and royalty rates on the fair values of our reporting units and brands with 10% or less excess fair value over carrying amount and between 10-20% excess fair value over carrying amount. These estimated changes in fair value are not necessarily representative of the actual impairment that would be recorded in the event of a fair value decline.
If we had changed the assumptions used to estimate the fair value of our reporting units and brands with 10% or less excess fair value over carrying amount, as of the latest 2019 impairment testing date for each of these reporting units and brands, these isolated changes, which are reasonably possible to occur, would have led to the following increase/(decrease) in the aggregate fair value of these reporting units and brands (in billions):
Discount Rate | Long-Term Growth Rate | Royalty Rate | |||||||||||||||||||||
50-Basis-Point | 25-Basis-Point | 100-Basis-Point | |||||||||||||||||||||
Increase | Decrease | Increase | Decrease | Increase | Decrease | ||||||||||||||||||
Reporting units | $ | (5.5 | ) | $ | 6.6 | $ | 2.7 | $ | (2.4 | ) | |||||||||||||
Brands (excess earnings method) | (1.4 | ) | 1.7 | 0.6 | (0.6 | ) | |||||||||||||||||
Brands (relief from royalty method) | (0.5 | ) | 0.6 | 0.2 | (0.2 | ) | $ | 0.6 | $ | (0.6 | ) |
If we had changed the assumptions used to estimate the fair value of our reporting units and brands with between 10-20% excess fair value over carrying amount, as of the latest 2019 impairment testing date for each of these reporting units and brands, these isolated changes, which are reasonably possible to occur, would have led to the following increase/(decrease) in the aggregate fair value of these reporting units and brands (in billions):
Discount Rate | Long-Term Growth Rate | Royalty Rate | |||||||||||||||||||||
50-Basis-Point | 100-Basis-Point | ||||||||||||||||||||||
Increase | Decrease | Increase | Decrease | Increase | Decrease | ||||||||||||||||||
Reporting units | $ | (0.2 | ) | $ | 0.2 | $ | 0.1 | $ | (0.1 | ) | |||||||||||||
Brands (excess earnings method) | (0.3 | ) | 0.3 | 0.1 | (0.1 | ) | |||||||||||||||||
Brands (relief from royalty method) | — | — | — | — | $ | 0.1 | $ | (0.1 | ) |
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Definite-lived intangible assets are amortized on a straight-line basis over the estimated periods benefited. We review definite-lived intangible assets for impairment when conditions exist that indicate the carrying amount of the assets may not be recoverable. Such conditions could include significant adverse changes in the business climate, current-period operating or cash flow losses, significant declines in forecasted operations, or a current expectation that an asset group will be disposed of before the end of its useful life. We perform undiscounted operating cash flow analyses to determine if an impairment exists. When testing for impairment of definite-lived intangible assets held for use, we group assets at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, the loss is calculated based on estimated fair value. Impairment losses on definite-lived intangible assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for our impairment testing results.
Postemployment Benefit Plans:
We maintain various retirement plans for the majority of our employees. These include pension benefits, postretirement health care benefits, and defined contribution benefits. The cost of these plans is charged to expense over an appropriate term based on, among other things, the cost component and whether the plan is active or inactive. Changes in the fair value of our plan assets result in net actuarial gains or losses. These net actuarial gains and losses are deferred into accumulated other comprehensive income/(losses) and amortized within other expense/(income) in future periods using the corridor approach. The corridor is 10% of the greater of the market-related value of the plan’s asset or projected benefit obligation. Any actuarial gains and losses in excess of the corridor are then amortized over an appropriate term based on whether the plan is active or inactive.
For our postretirement benefit plans, our 2020 health care cost trend rate assumption will be 6.5%. We established this rate based upon our most recent experience as well as our expectation for health care trend rates going forward. We anticipate the weighted average assumed ultimate trend rate will be 4.9%. The year in which the ultimate trend rate is reached varies by plan, ranging between the years 2020 and 2030. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have had the following effects, increase/(decrease) in cost and obligation, as of December 28, 2019 (in millions):
One-Percentage-Point | |||||||
Increase | (Decrease) | ||||||
Effect on annual service and interest cost | $ | 3 | $ | (2 | ) | ||
Effect on postretirement benefit obligation | 55 | (47 | ) |
Our 2020 discount rate assumption will be 3.3% for service cost and 2.7% for interest cost for our postretirement plans. Our 2020 discount rate assumption will be 3.6% for service cost and 3.0% for interest cost for our U.S. pension plans and 2.5% for service cost and 1.8% for interest cost for our non-U.S. pension plans. We model these discount rates using a portfolio of high quality, fixed-income debt instruments with durations that match the expected future cash flows of the plans. Changes in our discount rates were primarily the result of changes in bond yields year-over-year.
Our 2020 expected return on plan assets will be 4.7% (net of applicable taxes) for our postretirement plans. Our 2020 expected rate of return on plan assets will be 4.5% for our U.S. pension plans and 3.8% for our non-U.S. pension plans. We determine our expected rate of return on plan assets from the plan assets’ historical long-term investment performance, current and future asset allocation, and estimates of future long-term returns by asset class. We attempt to maintain our target asset allocation by re-balancing between asset classes as we make contributions and monthly benefit payments.
While we do not anticipate further changes in the 2020 assumptions for our U.S. and non-U.S. pension and postretirement benefit plans, as a sensitivity measure, a 100-basis-point change in our discount rate or a 100-basis-point change in the expected rate of return on plan assets would have the following effects, increase/(decrease) in cost (in millions):
U.S. Plans | Non-U.S. Plans | ||||||||||||||
100-Basis-Point | 100-Basis-Point | ||||||||||||||
Increase | Decrease | Increase | Decrease | ||||||||||||
Effect of change in discount rate on pension costs | $ | 11 | $ | (27 | ) | $ | 8 | $ | (5 | ) | |||||
Effect of change in expected rate of return on plan assets on pension costs | (47 | ) | 47 | (28 | ) | 28 | |||||||||
Effect of change in discount rate on postretirement costs | (8 | ) | 6 | (1 | ) | (1 | ) | ||||||||
Effect of change in expected rate of return on plan assets on postretirement costs | (11 | ) | 11 | — | — |
31
Income Taxes:
We compute our annual tax rate based on the statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we earn income. Significant judgment is required in determining our annual tax rate and in evaluating the uncertainty of our tax positions. We recognize a benefit for tax positions that we believe will more likely than not be sustained upon examination. The amount of benefit recognized is the largest amount of benefit that we believe has more than a 50% probability of being realized upon settlement. We regularly monitor our tax positions and adjust the amount of recognized tax benefit based on our evaluation of information that has become available since the end of our last financial reporting period. The annual tax rate includes the impact of these changes in recognized tax benefits. When adjusting the amount of recognized tax benefits, we do not consider information that has become available after the balance sheet date, however we do disclose the effects of new information whenever those effects would be material to our financial statements. Unrecognized tax benefits represent the difference between the amount of benefit taken or expected to be taken in a tax return and the amount of benefit recognized for financial reporting. These unrecognized tax benefits are recorded primarily within other non-current liabilities on the consolidated balance sheets.
We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. When assessing the need for valuation allowances, we consider future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, we would adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or decrease to income. The resolution of tax reserves and changes in valuation allowances could be material to our results of operations for any period but is not expected to be material to our financial position.
New Accounting Pronouncements
See Note 3, New Accounting Standards, in Item 8, Financial Statements and Supplementary Data, for a discussion of new accounting pronouncements.
Contingencies
See Note 17, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data, for a discussion of our contingencies.
Commodity Trends
We purchase and use large quantities of commodities, including dairy products, meat products, coffee beans, nuts, tomatoes, potatoes, soybean and vegetable oils, sugar and other sweeteners, corn products, and wheat products to manufacture our products. In addition, we purchase and use significant quantities of resins, metals, and cardboard to package our products and natural gas to operate our facilities. We continuously monitor worldwide supply and cost trends of these commodities.
We define our key commodities in the United States and Canada as dairy, meat, coffee, and nuts. In 2019, we experienced cost increases for dairy and meat, while costs for nuts and coffee decreased. We manage commodity cost volatility primarily through pricing and risk management strategies. As a result of these risk management strategies, our commodity costs may not immediately correlate with market price trends.
Dairy commodities, primarily milk and cheese, are the most significant cost components of our cheese products. We purchase our dairy raw material requirements from independent third parties, such as agricultural cooperatives and independent processors. Market supply and demand, as well as government programs, significantly influence the prices for milk and other dairy products. Significant cost components of our meat products include pork, beef, and poultry, which we primarily purchase from applicable local markets. Livestock feed costs and the global supply and demand for U.S. meats influence the prices of these meat products. The most significant cost component of our coffee products is coffee beans, which we purchase on global markets. Quality and availability of supply, currency fluctuations, and consumer demand for coffee products impact coffee bean prices. The most significant cost components in our nut products include peanuts, cashews, and almonds, which we purchase on both domestic and global markets, where global market supply and demand is the primary driver of prices.
32
Liquidity and Capital Resources
On February 14, 2020, Fitch and S&P downgraded our long-term credit rating from BBB- to BB+ with a stable outlook from Fitch and a negative outlook from S&P. As a result of the downgrades, our ability to borrow under our commercial paper program may be adversely affected for a period of time due to limitations on or elimination of our ability to access the commercial paper market. In addition, we could experience an increase in interest costs as a result of the downgrades. We do not expect any change in our plans to access liquidity over the next year as a result of the downgrades. These downgrades do not constitute a default or event of default under any of our debt instruments. Limitations on or elimination of our ability to access the commercial paper program may require us to borrow under the Senior Credit Facility, if necessary to meet liquidity needs. Our ability to borrow under the Senior Credit Facility is not affected by the downgrades.
We believe that cash generated from our operating activities and Senior Credit Facility will provide sufficient liquidity to meet our working capital needs, future contractual obligations (including repayments of long-term debt), payment of our anticipated quarterly dividends, planned capital expenditures, restructuring expenditures, and contributions to our postemployment benefit plans. An additional potential source of liquidity is access to capital markets. We intend to use our cash on hand for daily funding requirements and access to our Senior Credit Facility, if necessary. Overall, while we are not currently eligible to use a registration statement on Form S-3 for any public offerings of registered debt or equity securities to raise capital, we do not expect our ineligibility to use a registration statement on Form S-3 to have any negative effects on our funding sources that would have a material effect on our short-term or long-term liquidity.
Cash Flow Activity for 2019 Compared to 2018:
Net Cash Provided by/Used for Operating Activities:
Net cash provided by operating activities was $3.6 billion for the year ended December 28, 2019 compared to $2.6 billion for the year ended December 29, 2018. This increase was primarily driven by higher collections on trade receivables resulting from the reduction of receivables recorded as a non-cash exchange for sold receivables as we unwound all of our accounts receivable securitization and factoring programs (the “Programs”) in 2018 and as our trade receivables balance was higher at the end of 2018 compared to the end of 2017. This increase was partially offset by a federal tax refund received in the prior year, tax payments associated with the Heinz India Transaction, and increased cash payments for employee bonuses in 2019. See Note 16, Financing Arrangements, in Item 8, Financial Statements and Supplementary Data, for additional information on our Programs.
Net Cash Provided by/Used for Investing Activities:
Net cash provided by investing activities was $1.5 billion for the year ended December 28, 2019 compared to $288 million for the year ended December 29, 2018. This increase was primarily driven by proceeds from our Canada Natural Cheese Transaction and Heinz India Transaction, proceeds from our net investment hedges, lower capital expenditures, and lower cash payments to acquire businesses year over year. These increases in cash provided by investing activities were partially offset by lower cash collections on previously sold receivables, as we unwound all of our Programs in 2018. We expect 2020 capital expenditures to be approximately $750 million. See Note 4, Acquisitions and Divestitures, in Item 8, Financial Statements and Supplementary Data, for additional information on the Canada Natural Cheese Transaction, the Heinz India Transaction, and our acquisitions.
Net Cash Provided by/Used for Financing Activities:
Net cash used for financing activities was $3.9 billion for the year ended December 28, 2019 compared to $3.4 billion for the year ended December 29, 2018. This increase was primarily driven by higher repayments of long-term debt and higher debt prepayment and extinguishment costs, primarily related to our tender offers in September 2019 and debt redemptions in October 2019. These increases to net cash used for financing activities were partially offset by decreased cash distributions related to our dividends and lower net repayments of commercial paper. Proceeds from long-term debt issuances were mostly flat year over year. See Note 18, Debt, in Item 8, Financial Statements and Supplementary Data, for additional information on our tender offers. See Equity and Dividends in this item for additional information on our dividends.
Cash Held by International Subsidiaries:
Of the $2.3 billion cash and cash equivalents on our consolidated balance sheet at December 28, 2019, $869 million was held by international subsidiaries.
Subsequent to January 1, 2018, we consider the unremitted earnings of certain international subsidiaries that impose local country taxes on dividends to be indefinitely reinvested. For those undistributed earnings considered to be indefinitely reinvested, our intent is to reinvest these funds in our international operations, and our current plans do not demonstrate a need to repatriate the accumulated earnings to fund our U.S. cash requirements. The amount of unrecognized deferred tax liabilities for local country withholding taxes that would be owed related to our 2018 and 2019 accumulated earnings of certain international subsidiaries is approximately $70 million.
33
Our undistributed historic earnings in foreign subsidiaries through December 30, 2017 are currently not considered to be indefinitely reinvested. As of December 28, 2019, we have recorded a deferred tax liability of $20 million on approximately $300 million of historic earnings related to local withholding taxes that will be owed when this cash is distributed. As of December 29, 2018, we had recorded a deferred tax liability of $78 million on $1.2 billion of historic earnings. The decreases in our deferred tax liability and historic earnings are primarily due to repatriation. Related to these distributions, we reduced our historic earnings by approximately $700 million and recorded tax expenses of approximately $40 million and reduced the deferred tax liability accordingly. Additionally, we reduced our historic earnings by approximately $110 million following the ratification of the U.S. tax treaty with Spain, which eliminated withholding tax on Spanish distributions and resulted in a tax benefit of approximately $11 million and a corresponding decrease in our deferred tax liability. Finally, we reduced our historic earnings by approximately $30 million related to a held for sale business in our Rest of World segment, which resulted in a tax benefit of approximately $6 million.
Trade Payables Programs:
In order to manage our cash flow and related liquidity, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with our suppliers, which we deem to be commercially reasonable, generally range from 0 to 200 days. We also maintain agreements with third party administrators that allow participating suppliers to track payment obligations from us, and, at the sole discretion of the supplier, sell one or more of those payment obligations to participating financial institutions. We have no economic interest in a supplier’s decision to enter into these agreements and no direct financial relationship with the financial institutions. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. Supplier participation in these agreements is voluntary. We estimate that the amounts outstanding under these programs were $370 million at December 28, 2019 and $440 million at December 29, 2018.
Borrowing Arrangements:
We have historically obtained funding through our U.S. and European commercial paper programs. We had no commercial paper outstanding at December 28, 2019 or at December 29, 2018. The maximum amount of commercial paper outstanding during the year ended December 28, 2019 was $200 million.
We maintain our $4.0 billion Senior Credit Facility, and subject to certain conditions, we may increase the amount of revolving commitments and/or add additional tranches of term loans in a combined aggregate amount of up to $1.0 billion. No amounts were drawn on our Senior Credit Facility at December 28, 2019, at December 29, 2018, or during the years ended December 28, 2019, December 29, 2018, and December 30, 2017. The Senior Credit Facility contains representations, warranties, and covenants that are typical for these types of facilities and could, upon the occurrence of certain events of default, restrict our ability to access our Senior Credit Facility. We were in compliance with all financial covenants as of December 28, 2019.
Long-Term Debt:
Our long-term debt, including the current portion, was $29.2 billion at December 28, 2019 and $31.1 billion at December 29, 2018. This decrease was primarily related to the $2.9 billion aggregate principal amount of certain senior notes and second lien senior secured notes that were validly tendered in September 2019, the redemption of approximately $1.5 billion aggregate principal amount of senior notes in October 2019, and the repayment of $350 million aggregate principal amount of senior notes that matured in August 2019. These decreases to long-term debt were partially offset by the $3.0 billion aggregate principal amount of senior notes issued in September 2019. We used the proceeds from the issuance of these senior notes, together with cash on hand, to fund our tender offers in September 2019 and to pay fees and expenses in connection therewith, and to fund the partial redemption of $1.3 billion aggregate principal amount of our 2.800% senior notes due July 2020 and 300 million Canadian dollar senior notes due July 2020.
We repaid approximately $405 million aggregate principal amount of senior notes on February 10, 2020. We have aggregate principal amount of senior notes of approximately 500 million Canadian dollars and $200 million maturing in July 2020. We expect to fund these long-term debt repayments primarily with cash on hand and cash generated from our operating activities.
Our long-term debt contains customary representations, covenants, and events of default. We were in compliance with all financial covenants as of December 28, 2019.
See Note 18, Debt, in Item 8, Financial Statements and Supplementary Data, for additional information related to our long-term debt.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Off-Balance Sheet Arrangements:
We do not have guarantees or other off-balance sheet financing arrangements that we believe are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures, or capital resources.
34
We have utilized accounts receivable securitization and factoring programs globally for our working capital needs and to provide efficient liquidity. During 2018, we had Programs in place in various countries across the globe. In the second quarter of 2018, we unwound our U.S. securitization program, which represented the majority of our Programs, using proceeds from the issuance of long-term debt in June 2018. As of December 29, 2018, we had unwound all of our Programs.
See Note 16, Financing Arrangements, in Item 8, Financial Statements and Supplementary Data, for a discussion of our Programs and other financing arrangements.
Aggregate Contractual Obligations:
The following table summarizes our contractual obligations at December 28, 2019 (in millions):
Payments Due | ||||||||||||||
2020 | 2021-2022 | 2023-2024 | 2025 and Thereafter | Total | ||||||||||
Long-term debt(a) | 2,222 | 5,394 | 4,434 | 35,773 | 47,823 | |||||||||
Finance leases(b) | 33 | 96 | 17 | 80 | 226 | |||||||||
Operating leases(c) | 163 | 210 | 108 | 156 | 637 | |||||||||
Purchase obligations(d) | 1,324 | 1,038 | 493 | 89 | 2,944 | |||||||||
Other long-term liabilities(e) | 47 | 87 | 125 | 155 | 414 | |||||||||
Total | 3,789 | 6,825 | 5,177 | 36,253 | 52,044 |
(a) | Amounts represent the expected cash payments of our long-term debt, including interest on variable and fixed rate long-term debt. Interest on variable rate long-term debt is calculated based on interest rates at December 28, 2019. |
(b) | Amounts represent the expected cash payments of our finance leases, including expected cash payments of interest expense. |
(c) | Operating leases represent the minimum rental commitments under non-cancellable operating leases net of sublease income. |
(d) | We have purchase obligations for materials, supplies, property, plant and equipment, and co-packing, storage, and distribution services based on projected needs to be utilized in the normal course of business. Other purchase obligations include commitments for marketing, advertising, capital expenditures, information technology, and professional services. Arrangements are considered purchase obligations if a contract specifies all significant terms, including fixed or minimum quantities to be purchased, a pricing structure, and approximate timing of the transaction. Several of these obligations are long-term and are based on minimum purchase requirements. Certain purchase obligations contain variable pricing components, and, as a result, actual cash payments are expected to fluctuate based on changes in these variable components. Due to the proprietary nature of some of our materials and processes, certain supply contracts contain penalty provisions for early terminations. We do not believe that a material amount of penalties is reasonably likely to be incurred under these contracts based upon historical experience and current expectations. We exclude amounts reflected on the consolidated balance sheet as accounts payable and accrued liabilities from the table above. |
(e) | Other long-term liabilities primarily consist of estimated payments for the one-time toll charge related to U.S. Tax Reform, as well as postretirement benefit commitments. Certain other long-term liabilities related to income taxes, insurance accruals, and other accruals included on the consolidated balance sheet are excluded from the above table as we are unable to estimate the timing of payments for these items. |
Pension plan contributions were $19 million in 2019. We estimate that 2020 pension plan contributions will be approximately $19 million. Beyond 2020, we are unable to reliably estimate the timing of contributions to our pension plans. Our actual contributions and plans may change due to many factors, including changes in tax, employee benefit, or other laws and regulations, tax deductibility, significant differences between expected and actual pension asset performance or interest rates, or other factors. As such, estimated pension plan contributions for 2020 have been excluded from the above table.
Postretirement benefit plan contributions were $12 million in 2019. We estimate that 2020 postretirement benefit plan contributions will be approximately $15 million. Beyond 2020, we are unable to reliably estimate the timing of contributions to our postretirement benefit plans. Our actual contributions and plans may change due to many factors, including changes in tax, employee benefit, or other laws and regulations, tax deductibility, significant differences between expected and actual postretirement plan asset performance or interest rates, or other factors. As such, estimated postretirement benefit plan contributions for 2020 have been excluded from the above table.
At December 28, 2019, the amount of net unrecognized tax benefits for uncertain tax positions, including an accrual of related interest and penalties along with positions only impacting the timing of tax benefits, was approximately $468 million. The timing of payments will depend on the progress of examinations with tax authorities. We do not expect a significant tax payment related to these obligations within the next year. We are unable to make a reasonably reliable estimate as to if or when any significant cash settlements with taxing authorities may occur; therefore, we have excluded the amount of net unrecognized tax benefits from the above table.
35
Equity and Dividends
We paid common stock dividends of $2.0 billion in 2019, $3.2 billion in 2018, and $2.9 billion in 2017. Additionally, on February 13, 2020, our Board of Directors declared a cash dividend of $0.40 per share of common stock, which is payable on March 27, 2020 to shareholders of record on March 13, 2020.
The declaration of dividends is subject to the discretion of our Board of Directors and depends on various factors, including our net income, financial condition, cash requirements, future prospects, and other factors that our Board of Directors deems relevant to its analysis and decision making.
Non-GAAP Financial Measures
The non-GAAP financial measures we provide in this report should be viewed in addition to, and not as an alternative for, results prepared in accordance with U.S. GAAP.
To supplement the consolidated financial statements prepared in accordance with U.S. GAAP, we have presented Organic Net Sales, Adjusted EBITDA, and Adjusted EPS, which are considered non-GAAP financial measures. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. These measures are not substitutes for their comparable U.S. GAAP financial measures, such as net sales, net income/(loss), diluted earnings per common share (“EPS”), or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures.
Management uses these non-GAAP financial measures to assist 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 underlying operations. Management believes that presenting our non-GAAP financial measures (i.e., Organic Net Sales, Adjusted EBITDA, and Adjusted EPS) is useful to investors because it (i) provides investors with meaningful supplemental information regarding financial performance by excluding certain items, (ii) permits investors to view performance using the same tools that management uses to budget, make operating and strategic decisions, and evaluate historical performance, and (iii) otherwise provides supplemental information that may be useful to investors in evaluating our results. We believe that the presentation of these non-GAAP financial measures, when considered together with the corresponding U.S. GAAP financial measures and the reconciliations to those measures, provides investors with additional understanding of the factors and trends affecting our business than could be obtained absent these disclosures.
Organic Net Sales is defined as net sales excluding, when they occur, the impact of currency, acquisitions and divestitures, and a 53rd week of shipments. We calculate the impact of currency on net sales by holding exchange rates constant at the previous year’s exchange rate, with the exception of highly inflationary subsidiaries, for which we calculate the previous year’s results using the current year’s exchange rate. Organic Net Sales is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Adjusted EBITDA is defined as net income/(loss) from continuing operations before interest expense, other expense/(income), provision for/(benefit from) income taxes, and depreciation and amortization (excluding integration and restructuring expenses); in addition to these adjustments, we exclude, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized losses/(gains) on commodity hedges, impairment losses, and equity award compensation expense (excluding integration and restructuring expenses). Adjusted EBITDA is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Adjusted EPS is defined as diluted earnings per share excluding, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized losses/(gains) on commodity hedges, impairment losses, losses/(gains) on the sale of a business, other losses/(gains) related to acquisitions and divestitures (e.g., tax and hedging impacts), nonmonetary currency devaluation (e.g., remeasurement gains and losses), debt prepayment and extinguishment costs, and U.S. Tax Reform discrete income tax expense/(benefit), and including, when they occur, adjustments to reflect preferred stock dividend payments on an accrual basis. We believe Adjusted EPS provides important comparability of underlying operating results, allowing investors and management to assess operating performance on a consistent basis.
36
The Kraft Heinz Company
Reconciliation of Net Sales to Organic Net Sales
(dollars in millions)
(Unaudited)
Net Sales | Currency | Acquisitions and Divestitures | Organic Net Sales | Price | Volume/Mix | ||||||||||||||
2019 | |||||||||||||||||||
United States | $ | 17,756 | $ | — | $ | — | $ | 17,756 | |||||||||||
Canada | 1,882 | (45 | ) | 227 | 1,700 | ||||||||||||||
EMEA | 2,551 | (115 | ) | — | 2,666 | ||||||||||||||
Rest of World | 2,788 | (102 | ) | 51 | 2,839 | ||||||||||||||
Kraft Heinz | $ | 24,977 | $ | (262 | ) | $ | 278 | $ | 24,961 | ||||||||||
2018 | |||||||||||||||||||
United States | $ | 18,122 | $ | — | $ | — | $ | 18,122 | |||||||||||
Canada | 2,173 | — | 441 | 1,732 | |||||||||||||||
EMEA | 2,718 | — | 21 | 2,697 | |||||||||||||||
Rest of World | 3,255 | 243 | 170 | 2,842 | |||||||||||||||
Kraft Heinz | $ | 26,268 | $ | 243 | $ | 632 | $ | 25,393 |
Year-over-year growth rates | |||||||||||||
United States | (2.0 | )% | 0.0 pp | 0.0 pp | (2.0 | )% | 0.4 pp | (2.4) pp | |||||
Canada | (13.4 | )% | (2.1) pp | (9.4) pp | (1.9 | )% | (3.4) pp | 1.5 pp | |||||
EMEA | (6.2 | )% | (4.3) pp | (0.7) pp | (1.2 | )% | 0.0 pp | (1.2) pp | |||||
Rest of World | (14.3 | )% | (10.3) pp | (3.9) pp | (0.1 | )% | 1.2 pp | (1.3) pp | |||||
Kraft Heinz | (4.9 | )% | (1.9) pp | (1.3) pp | (1.7 | )% | 0.1 pp | (1.8) pp |
37
The Kraft Heinz Company
Reconciliation of Net Sales to Organic Net Sales
(dollars in millions)
(Unaudited)
Net Sales | Currency | Acquisitions and Divestitures | Organic Net Sales | Price | Volume/Mix | ||||||||||||||
2018 | |||||||||||||||||||
United States | $ | 18,122 | $ | — | $ | — | $ | 18,122 | |||||||||||
Canada | 2,173 | (5 | ) | 443 | 1,735 | ||||||||||||||
EMEA | 2,718 | 66 | 19 | 2,633 | |||||||||||||||
Rest of World | 3,255 | (75 | ) | 334 | 2,996 | ||||||||||||||
Kraft Heinz | $ | 26,268 | $ | (14 | ) | $ | 796 | $ | 25,486 | ||||||||||
2017 | |||||||||||||||||||
United States | $ | 18,230 | $ | — | $ | — | $ | 18,230 | |||||||||||
Canada | 2,177 | — | 430 | 1,747 | |||||||||||||||
EMEA | 2,585 | — | 56 | 2,529 | |||||||||||||||
Rest of World | 3,084 | 144 | 165 | 2,775 | |||||||||||||||
Kraft Heinz | $ | 26,076 | $ | 144 | $ | 651 | $ | 25,281 |
Year-over-year growth rates | |||||||||||||
United States | (0.6 | )% | 0.0 pp | 0.0 pp | (0.6 | )% | (0.9) pp | 0.3 pp | |||||
Canada | (0.2 | )% | (0.3) pp | 0.7 pp | (0.6 | )% | (0.4) pp | (0.2) pp | |||||
EMEA | 5.1 | % | 2.5 pp | (1.5) pp | 4.1 | % | 0.9 pp | 3.2 pp | |||||
Rest of World | 5.6 | % | (7.6) pp | 5.2 pp | 8.0 | % | 6.1 pp | 1.9 pp | |||||
Kraft Heinz | 0.7 | % | (0.6) pp | 0.5 pp | 0.8 | % | 0.0 pp | 0.8 pp |
38
The Kraft Heinz Company
Reconciliation of Net Income/(Loss) to Adjusted EBITDA
(in millions)
(Unaudited)
December 28, 2019 | December 29, 2018 | December 30, 2017 | |||||||||
Net income/(loss) | $ | 1,933 | $ | (10,254 | ) | $ | 10,932 | ||||
Interest expense | 1,361 | 1,284 | 1,234 | ||||||||
Other expense/(income) | (952 | ) | (168 | ) | (627 | ) | |||||
Provision for/(benefit from) income taxes | 728 | (1,067 | ) | (5,482 | ) | ||||||
Operating income/(loss) | 3,070 | (10,205 | ) | 6,057 | |||||||
Depreciation and amortization (excluding integration and restructuring expenses) | 985 | 919 | 907 | ||||||||
Integration and restructuring expenses | 102 | 297 | 583 | ||||||||
Deal costs | 19 | 23 | — | ||||||||
Unrealized losses/(gains) on commodity hedges | (57 | ) | 21 | 19 | |||||||
Impairment losses | 1,899 | 15,936 | 49 | ||||||||
Equity award compensation expense (excluding integration and restructuring expenses) | 46 | 33 | 49 | ||||||||
Adjusted EBITDA | $ | 6,064 | $ | 7,024 | $ | 7,664 |
39
The Kraft Heinz Company
Reconciliation of Diluted EPS to Adjusted EPS
(Unaudited)
December 28, 2019 | December 29, 2018 | December 30, 2017 | |||||||||
Diluted EPS | $ | 1.58 | $ | (8.36 | ) | $ | 8.91 | ||||
Integration and restructuring expenses(a) | 0.07 | 0.32 | 0.24 | ||||||||
Deal costs(b) | 0.02 | 0.02 | — | ||||||||
Unrealized losses/(gains) on commodity hedges(c) | (0.04 | ) | 0.01 | 0.01 | |||||||
Impairment losses(d) | 1.38 | 11.28 | 0.03 | ||||||||
Losses/(gains) on sale of business(e) | (0.23 | ) | 0.01 | — | |||||||
Other losses/(gains) related to acquisitions and divestitures(f) | — | 0.02 | — | ||||||||
Nonmonetary currency devaluation(g) | 0.01 | 0.12 | 0.03 | ||||||||
Debt prepayment and extinguishment costs(h) | 0.06 | — | — | ||||||||
U.S. Tax Reform discrete income tax expense/(benefit)(i) | — | 0.09 | (5.72 | ) | |||||||
Adjusted EPS | $ | 2.85 | $ | 3.51 | $ | 3.50 |
(a) | Gross expenses included in integration and restructuring expenses were $108 million in 2019 ($83 million after-tax), $460 million in 2018 ($396 million after-tax) and $434 million in 2017 ($305 million after-tax) and were recorded in the following income statement line items: |
• | Cost of products sold included $48 million in 2019, $194 million in 2018, and $464 million in 2017; |
• | SG&A included $54 million in 2019, $103 million in 2018, and $119 million in 2017; and |
• | Other expense/(income) included expense of $6 million in 2019, expense of $163 million in 2018, and income of $149 million in 2017. |
(b) | Gross expenses included in deal costs were $19 million in 2019 ($18 million after-tax) and $23 million in 2018 ($19 million after-tax) and were recorded in the following income statement line items: |
• | Cost of products sold included $4 million in 2018; and |
• | SG&A included $19 million in 2019 and $19 million in 2018. |
(c) | Gross expenses/(income) included in unrealized losses/(gains) on commodity hedges were income of $57 million in 2019 ($43 million after-tax) and expenses of $21 million in 2018 ($16 million after-tax) and $19 million in 2017 ($12 million after-tax) and were recorded in cost of products sold. |
(d) | Gross impairment losses, which were recorded in SG&A, included the following: |
• | Goodwill impairment losses of $1.2 billion in 2019 ($1.2 billion after-tax) and $7.0 billion in 2018 ($7.0 billion after-tax); and |
• | Intangible asset impairment losses of $702 million in 2019 ($537 million after-tax), $8.9 billion in 2018 ($6.8 billion after-tax), and $49 million in 2017 ($36 million after-tax). |
(e) | Gross expenses/(income) included in losses/(gains) on sale of business were income of $420 million in 2019 ($275 million after-tax) and losses of $15 million in 2018 ($15 million after-tax) and were recorded in other expense/(income). |
(f) | Gross expenses/(income) included in other losses/(gains) related to acquisitions and divestitures were income of $5 million in 2019 ($5 million after-tax) and expenses of $27 million in 2018 ($15 million after-tax) and were recorded in the following income statement line items: |
• | Interest expense included $1 million in 2019 and $3 million in 2018; |
• | Other expense/(income) included income of $6 million in 2019 and expenses of $17 million in 2018; and |
• | Provision for/(benefit from) income taxes included $7 million in 2018. |
(g) | Gross expenses included in nonmonetary currency devaluation were $10 million in 2019 ($10 million after-tax), $146 million in 2018 ($146 million after-tax), and $36 million in 2017 ($36 million after-tax) and were recorded in other expense/(income). |
(h) | Gross expenses included in debt prepayment and extinguishment costs were $98 million in 2019 ($73 million after-tax) and were recorded in interest expense. |
(i) | U.S. Tax Reform discrete income tax expense/(benefit) was an expense of $104 million in 2018 and a benefit of $7.0 billion in 2017. Expenses in 2018 primarily related to the revaluation of our deferred tax balances due to changes in state tax laws following U.S. Tax Reform. These expenses were partially offset by net benefits related to changes in U.S. tax reserves, U.S. Tax Reform measurement period adjustments, changes in estimates of certain 2017 U.S. income tax deductions, and the release of valuation allowances related to foreign tax credits. The benefit in 2017 was related to the enactment of U.S. Tax Reform. See Note 10, Income Taxes, in Item 8, Financial Statements and Supplementary Data, for additional information. |
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to market risks from adverse changes in commodity prices, foreign exchange rates, and interest rates. We monitor and manage these exposures as part of our overall risk management program. Our risk management program focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that volatility in these markets may have on our operating results. We maintain risk management policies that principally use derivative financial instruments to reduce significant, unanticipated fluctuations in earnings and cash flows that may arise from variations in commodity prices, foreign currency exchange rates, and interest rates. We manage market risk by incorporating parameters within our risk management strategy that limit the types of derivative instruments, the derivative strategies we use, and the degree of market risk that we hedge with derivative instruments. See Note 2, Significant Accounting Policies, and Note 13, Financial Instruments, in Item 8, Financial Statements and Supplementary Data, for details of our market risk management policies and the financial instruments used to hedge those exposures.
When we use financial instruments, we are exposed to credit risk that a counterparty might fail to fulfill its performance obligations under the terms of our agreement. We minimize our credit risk by entering into transactions with counterparties with investment grade credit ratings, limiting the amount of exposure we have with each counterparty, and monitoring the financial condition of our counterparties. We maintain a policy of requiring that all significant, non-exchange traded derivative contracts are governed by an International Swaps and Derivatives Association master agreement. By policy, we do not engage in speculative or leveraged transactions, nor do we hold or issue financial instruments for trading purposes.
Effect of Hypothetical 10% Fluctuation in Market Prices:
The potential gain or loss on the fair value of our outstanding commodity contracts, foreign exchange contracts, and cross-currency swap contracts, assuming a hypothetical 10% fluctuation in commodity prices and foreign currency exchange rates, would have been (in millions):
December 28, 2019 | December 29, 2018 | ||||||
Commodity contracts | $ | 43 | $ | 38 | |||
Foreign currency contracts | 73 | 100 | |||||
Cross-currency swap contracts | 412 | 402 |
It should be noted that any change in the fair value of our derivative contracts, real or hypothetical, would be significantly offset by an inverse change in the value of the underlying hedged items. In relation to foreign currency contracts, this hypothetical calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar. Our utilization of financial instruments in managing market risk exposures described above is consistent with the prior year. Changes in our portfolio of financial instruments are a function of our results of operations, debt repayments and debt issuances, market effects on debt and foreign currency, and our acquisition and divestiture activities.
Effect of Hypothetical 1% Fluctuation in LIBOR and CDOR:
Based on our current variable rate debt balance as of December 28, 2019, a hypothetical 1% increase in LIBOR and CDOR would increase our annual interest expense by approximately $12 million. The Financial Conduct Authority in the United Kingdom intends to phase out LIBOR by the end of 2021. Given our current variable rate debt outstanding, we do not anticipate a significant impact to our annual interest expense as a result of the transition.
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Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of The Kraft Heinz Company
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of The Kraft Heinz Company and its subsidiaries (the “Company”) as of December 28, 2019 and December 29, 2018, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 28, 2019, including the related notes and financial statement schedule listed in the index appearing under Item 15(a) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 28, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2019 and December 29, 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 28, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 28, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO because material weaknesses in internal control over financial reporting existed as of that date related to the risk assessment component of internal control, as the Company did not appropriately design controls in response to the risk of material misstatement due to changes in their business environment. The risk assessment material weakness gave rise to an additional material weakness as the Company did not design and maintain effective controls over the accounting for supplier contracts and related arrangements.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2019 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
Change in Accounting Principle
As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in management's report referred to above. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by
42
management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Goodwill Impairment Assessment
As described in Notes 2 and 9 to the consolidated financial statements, the Company’s consolidated goodwill balance was $35.5 billion as of December 28, 2019. Management tests reporting units for impairment annually as of the first day of the second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Management recognized non-cash impairment losses in selling, general and administrative costs (SG&A) of $1.2 billion for the year ended December 28, 2019. Reporting units are tested for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its estimated fair value, an impairment loss is recorded based on the difference between the fair value and carrying amount, not to exceed the associated carrying amount of goodwill. Management generally utilizes the discounted cash flow method under the income approach to estimate the fair value of reporting units. Estimating the fair value of reporting units requires the use of estimates and assumptions, including estimated future annual net cash flows (including net sales, cost of products sold, SG&A, depreciation and amortization, working capital, and capital expenditures), income tax rates, discount rates, long-term growth rates and other market factors.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment is a critical audit matter are there was significant judgment by management when developing the fair value measurement of the reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing our procedures and in evaluating management’s cash flow projections and significant assumptions, including net sales, cost of products sold, SG&A, discount rates and long-term growth rates. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the valuation of the Company’s reporting units. These procedures also included, among others (i) testing management’s process for developing the fair value estimates, (ii) evaluating the appropriateness of the discounted cash flow method, (iii) testing the completeness and accuracy of underlying data used in
43
the fair value estimates, and (iv) evaluating management’s cash flow projections and significant assumptions including net sales, cost of products sold, SG&A, discount rates and long-term growth rates. Evaluating management’s assumptions related to net sales, cost of products sold, SG&A, discount rates and long-term growth rates involved evaluating whether the assumptions used were reasonable considering (i) the current and past performance of the reporting unit, (ii) the consistency with market data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s discounted cash flow method and certain significant assumptions, including the discount rates and long-term growth rates.
Indefinite-Lived Intangible Assets Impairment Assessment
As described in Notes 2 and 9 to the consolidated financial statements, the Company’s consolidated indefinite-lived intangible assets balance, which consists primarily of individual brands, was $43.4 billion as of December 28, 2019. Management conducts an impairment test annually as of the first day of the second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a brand is less than its carrying amount. Management recognized non-cash impairment losses of $687 million in SG&A for the year ended December 28, 2019. Brands are tested for impairment by comparing the estimated fair value of each brand with its carrying amount. If the carrying amount of a brand exceeds its estimated fair value, an impairment loss is recorded based on the difference between the fair value and carrying amount. Management utilizes either an excess earnings method or relief from royalty method to estimate the fair value of its brands. The determination of fair value using the excess earnings method requires the use of estimates and assumptions including the estimated future annual net cash flows for each brand (including net sales, cost of products sold, and SG&A), contributory asset charges, income tax considerations, long-term growth rates, discount rates and other market factors. The determination of fair value using the relief from royalty method requires the use of estimates and assumptions including estimated future annual net sales for each brand, royalty rates, income tax considerations, long-term growth rates, discount rates and other market factors.
The principal considerations for our determination that performing procedures relating to the indefinite-lived intangible assets impairment assessment is a critical audit matter are there was significant judgment by management when developing the fair value measurement of the brands. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing our procedures related to indefinite-lived intangible assets and in evaluating management’s cash flow projections and significant assumptions, including net sales, cost of products sold, SG&A, long-term growth rates and discount rates for the excess earnings method and net sales, royalty rates, long-term growth rates and discount rates for the relief from royalty method. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained. As previously disclosed by management, a material weakness existed during the year related to this matter.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s indefinite-lived intangible assets impairment assessment, including controls over the valuation of the Company’s indefinite-lived intangible assets. These procedures also included, among others (i) testing management’s process for developing the fair value estimates, (ii) evaluating the appropriateness of the excess earnings and relief from royalty methods, (iii) testing the completeness and accuracy of underlying data used in the fair value estimates, and (iv) evaluating management’s cash flow projections and significant assumptions including net sales, cost of products sold, SG&A, long-term growth rates and discount rates for the excess earnings method and net sales, royalty rates, long-term growth rates and discount rates for the relief from royalty method. Evaluating management’s assumptions related to net sales, cost of products sold, SG&A, long-term growth rates and discount rates for the excess earnings method and net sales, royalty rates, long-term growth rates and discount rates for the relief from royalty method involved evaluating whether the assumptions used were reasonable considering (i) the current and past performance of the brand, (ii) the consistency with market data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s excess earnings and relief from royalty methods and certain significant assumptions, including the royalty rates, long-term growth rates and discount rates.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 14, 2020
We have served as the Company’s or its predecessors' auditor since 1979.
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The Kraft Heinz Company
Consolidated Statements of Income
(in millions, except per share data)
December 28, 2019 | December 29, 2018 | December 30, 2017 | |||||||||
Net sales | $ | 24,977 | $ | 26,268 | $ | 26,076 | |||||
Cost of products sold | 16,830 | 17,347 | 17,043 | ||||||||
Gross profit | 8,147 | 8,921 | 9,033 | ||||||||
Selling, general and administrative expenses, excluding impairment losses | 3,178 | 3,190 | 2,927 | ||||||||
Goodwill impairment losses | 1,197 | 7,008 | — | ||||||||
Intangible asset impairment losses | 702 | 8,928 | 49 | ||||||||
Selling, general and administrative expenses | 5,077 | 19,126 | 2,976 | ||||||||
Operating income/(loss) | 3,070 | (10,205 | ) | 6,057 | |||||||
Interest expense | 1,361 | 1,284 | 1,234 | ||||||||
Other expense/(income) | (952 | ) | (168 | ) | (627 | ) | |||||
Income/(loss) before income taxes | 2,661 | (11,321 | ) | 5,450 | |||||||
Provision for/(benefit from) income taxes | 728 | (1,067 | ) | (5,482 | ) | ||||||
Net income/(loss) | 1,933 | (10,254 | ) | 10,932 | |||||||
Net income/(loss) attributable to noncontrolling interest | (2 | ) | (62 | ) | (9 | ) | |||||
Net income/(loss) attributable to common shareholders | $ | 1,935 | $ | (10,192 | ) | $ | 10,941 | ||||
Per share data applicable to common shareholders: | |||||||||||
Basic earnings/(loss) | $ | 1.59 | $ | (8.36 | ) | $ | 8.98 | ||||
Diluted earnings/(loss) | 1.58 | (8.36 | ) | 8.91 |
See accompanying notes to the consolidated financial statements.
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The Kraft Heinz Company
Consolidated Statements of Comprehensive Income
(in millions)
December 28, 2019 | December 29, 2018 | December 30, 2017 | |||||||||
Net income/(loss) | $ | 1,933 | $ | (10,254 | ) | $ | 10,932 | ||||
Other comprehensive income/(loss), net of tax: | |||||||||||
Foreign currency translation adjustments | 246 | (1,187 | ) | 1,185 | |||||||
Net deferred gains/(losses) on net investment hedges | 1 | 284 | (353 | ) | |||||||
Amounts excluded from the effectiveness assessment of net investment hedges | 22 | 7 | — | ||||||||
Net deferred losses/(gains) on net investment hedges reclassified to net income/(loss) | (16 | ) | (7 | ) | — | ||||||
Net deferred gains/(losses) on cash flow hedges | (10 | ) | 99 | (113 | ) | ||||||
Amounts excluded from the effectiveness assessment of cash flow hedges | 29 | 2 | — | ||||||||
Net deferred losses/(gains) on cash flow hedges reclassified to net income/(loss) | (41 | ) | (44 | ) | 85 | ||||||
Net actuarial gains/(losses) arising during the period | (70 | ) | 58 | 69 | |||||||
Prior service credits/(costs) arising during the period | 1 | 3 | 17 | ||||||||
Net postemployment benefit losses/(gains) reclassified to net income/(loss) | (234 | ) | (118 | ) | (309 | ) | |||||
Total other comprehensive income/(loss) | (72 | ) | (903 | ) | 581 | ||||||
Total comprehensive income/(loss) | 1,861 | (11,157 | ) | 11,513 | |||||||
Comprehensive income/(loss) attributable to noncontrolling interest | 5 | (76 | ) | (3 | ) | ||||||
Comprehensive income/(loss) attributable to common shareholders | $ | 1,856 | $ | (11,081 | ) | $ | 11,516 |
See accompanying notes to the consolidated financial statements.
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The Kraft Heinz Company
Consolidated Balance Sheets
(in millions, except per share data)
December 28, 2019 | December 29, 2018 | ||||||
ASSETS | |||||||
Cash and cash equivalents | $ | 2,279 | $ | 1,130 | |||
Trade receivables (net of allowances of $33 at December 28, 2019 and $24 at December 29, 2018) | 1,973 | 2,129 | |||||
Income taxes receivable | 173 | 152 | |||||
Inventories | 2,721 | 2,667 | |||||
Prepaid expenses | 384 | 400 | |||||
Other current assets | 445 | 1,221 | |||||
Assets held for sale | 122 | 1,376 | |||||
Total current assets | 8,097 | 9,075 | |||||
Property, plant and equipment, net | 7,055 | 7,078 | |||||
Goodwill | 35,546 | 36,503 | |||||
Intangible assets, net | 48,652 | 49,468 | |||||
Other non-current assets | 2,100 | 1,337 | |||||
TOTAL ASSETS | $ | 101,450 | $ | 103,461 | |||
LIABILITIES AND EQUITY | |||||||
Commercial paper and other short-term debt | $ | 6 | $ | 21 | |||
Current portion of long-term debt | 1,022 | 377 | |||||
Trade payables | 4,003 | 4,153 | |||||
Accrued marketing | 647 | 722 | |||||
Interest payable | 384 | 408 | |||||
Other current liabilities | 1,804 | 1,767 | |||||
Liabilities held for sale | 9 | 55 | |||||
Total current liabilities | 7,875 | 7,503 | |||||
Long-term debt | 28,216 | 30,770 | |||||
Deferred income taxes | 11,878 | 12,202 | |||||
Accrued postemployment costs | 273 | 306 | |||||
Other non-current liabilities | 1,459 | 902 | |||||
TOTAL LIABILITIES | 49,701 | 51,683 | |||||
Commitments and Contingencies (Note 17) | |||||||
Redeemable noncontrolling interest | — | 3 | |||||
Equity: | |||||||
Common stock, $0.01 par value (5,000 shares authorized; 1,224 shares issued and 1,221 shares outstanding at December 28, 2019; 1,224 shares issued and 1,220 shares outstanding at December 29, 2018) | 12 | 12 | |||||
Additional paid-in capital | 56,828 | 58,723 | |||||
Retained earnings/(deficit) | (3,060 | ) | (4,853 | ) | |||
Accumulated other comprehensive income/(losses) | (1,886 | ) | (1,943 | ) | |||
Treasury stock, at cost (3 shares at December 28, 2019 and 4 shares at December 29, 2018) | (271 | ) | (282 | ) | |||
Total shareholders' equity | 51,623 | 51,657 | |||||
Noncontrolling interest | 126 | 118 | |||||
TOTAL EQUITY | 51,749 | 51,775 | |||||
TOTAL LIABILITIES AND EQUITY | $ | 101,450 | $ | 103,461 |
See accompanying notes to the consolidated financial statements.
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The Kraft Heinz Company
Consolidated Statements of Equity
(in millions)
Common Stock | Additional Paid-in Capital | Retained Earnings/(Deficit) | Accumulated Other Comprehensive Income/(Losses) | Treasury Stock, at Cost | Noncontrolling Interest | Total Equity | |||||||||||||||||||||
Balance at December 31, 2016 | $ | 12 | $ | 58,516 | $ | 552 | $ | (1,629 | ) | $ | (207 | ) | $ | 216 | $ | 57,460 | |||||||||||
Net income/(loss) excluding redeemable noncontrolling interest | — | — | 10,941 | — | — | (5 | ) | 10,936 | |||||||||||||||||||
Other comprehensive income/(loss) | — | — | — | 575 | — | 6 | 581 | ||||||||||||||||||||
Dividends declared-common stock ($2.45 per share) | — | — | (2,988 | ) | — | — | — | (2,988 | ) | ||||||||||||||||||
Dividends declared-noncontrolling interest ($52.75 per share) | — | — | — | — | — | (10 | ) | (10 | ) | ||||||||||||||||||
Exercise of stock options, issuance of other stock awards, and other | — | 118 | (10 | ) | — | (17 | ) | — | 91 | ||||||||||||||||||
Balance at December 30, 2017 | 12 | 58,634 | 8,495 | (1,054 | ) | (224 | ) | 207 | 66,070 | ||||||||||||||||||
Net income/(loss) excluding redeemable noncontrolling interest | — | — | (10,192 | ) | — | — | (50 | ) | (10,242 | ) | |||||||||||||||||
Other comprehensive income/(loss) | — | — | — | (889 | ) | — | (14 | ) | (903 | ) | |||||||||||||||||
Dividends declared-common stock ($2.50 per share) | — | — | (3,048 | ) | — | — | — | (3,048 | ) | ||||||||||||||||||
Dividends declared-noncontrolling interest ($174.76 per share) | — | — | — | — | — | (12 | ) | (12 | ) | ||||||||||||||||||
Cumulative effect of accounting standards adopted in the period | — | — | (97 | ) | — | — | — | (97 | ) | ||||||||||||||||||
Exercise of stock options, issuance of other stock awards, and other | — | 89 | (11 | ) | — | (58 | ) | (13 | ) | 7 | |||||||||||||||||
Balance at December 29, 2018 | 12 | 58,723 | (4,853 | ) | (1,943 | ) | (282 | ) | 118 | 51,775 | |||||||||||||||||
Net income/(loss) excluding redeemable noncontrolling interest | — | — | 1,935 | — | — | 6 | 1,941 | ||||||||||||||||||||
Other comprehensive income/(loss) | — | — | — | (79 | ) | — | 7 | (72 | ) | ||||||||||||||||||
Dividends declared-common stock ($1.60 per share) | — | (1,959 | ) | — | — | — | — | (1,959 | ) | ||||||||||||||||||
Dividends declared-noncontrolling interest ($75.63 per share) | — | — | — | — | — | (5 | ) | (5 | ) | ||||||||||||||||||
Cumulative effect of accounting standards adopted in the period | — | — | (136 | ) | 136 | — | — | — | |||||||||||||||||||
Exercise of stock options, issuance of other stock awards, and other | — | 64 | (6 | ) | — | 11 | — | 69 | |||||||||||||||||||
Balance at December 28, 2019 | $ | 12 | $ | 56,828 | $ | (3,060 | ) | $ | (1,886 | ) | $ | (271 | ) | $ | 126 | $ | 51,749 |
See accompanying notes to the consolidated financial statements.
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The Kraft Heinz Company
Consolidated Statements of Cash Flows
(in millions)
December 28, 2019 | December 29, 2018 | December 30, 2017 | |||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||||||
Net income/(loss) | $ | 1,933 | $ | (10,254 | ) | $ | 10,932 | ||||
Adjustments to reconcile net income/(loss) to operating cash flows: | |||||||||||
Depreciation and amortization | 994 | 983 | 1,031 | ||||||||
Amortization of postretirement benefit plans prior service costs/(credits) | (306 | ) | (339 | ) | (328 | ) | |||||
Equity award compensation expense | 46 | 33 | 46 | ||||||||
Deferred income tax provision/(benefit) | (293 | ) | (1,967 | ) | (6,495 | ) | |||||
Postemployment benefit plan contributions | (32 | ) | (76 | ) | (1,659 | ) | |||||
Goodwill and intangible asset impairment losses | 1,899 | 15,936 | 49 | ||||||||
Nonmonetary currency devaluation | 10 | 146 | 36 | ||||||||
Loss/(gain) on sale of business | (420 | ) | 15 | — | |||||||
Other items, net | (46 | ) | 160 | 253 | |||||||
Changes in current assets and liabilities: | |||||||||||
Trade receivables | 140 | (2,280 | ) | (2,629 | ) | ||||||
Inventories | (277 | ) | (251 | ) | (236 | ) | |||||
Accounts payable | (58 | ) | (23 | ) | 441 | ||||||
Other current assets | 52 | (146 | ) | (64 | ) | ||||||
Other current liabilities | (90 | ) | 637 | (876 | ) | ||||||
Net cash provided by/(used for) operating activities | 3,552 | 2,574 | 501 | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
Cash receipts on sold receivables | — | 1,296 | 2,286 | ||||||||
Capital expenditures | (768 | ) | (826 | ) | (1,194 | ) | |||||
Payments to acquire business, net of cash acquired | (199 | ) | (248 | ) | — | ||||||
Proceeds from net investment hedges | 590 | 24 | 6 | ||||||||
Proceeds from sale of business, net of cash disposed | 1,875 | 18 | — | ||||||||
Other investing activities, net | 13 | 24 | 79 | ||||||||
Net cash provided by/(used for) investing activities | 1,511 | 288 | 1,177 | ||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||||||
Repayments of long-term debt | (4,795 | ) | (2,713 | ) | (2,641 | ) | |||||
Proceeds from issuance of long-term debt | 2,967 | 2,990 | 1,496 | ||||||||
Debt prepayment and extinguishment costs | (99 | ) | — | — | |||||||
Proceeds from issuance of commercial paper | 557 | 2,784 | 6,043 | ||||||||
Repayments of commercial paper | (557 | ) | (3,213 | ) | (6,249 | ) | |||||
Dividends paid | (1,953 | ) | (3,183 | ) | (2,888 | ) | |||||
Other financing activities, net | (33 | ) | (28 | ) | 18 | ||||||
Net cash provided by/(used for) financing activities | (3,913 | ) | (3,363 | ) | (4,221 | ) | |||||
Effect of exchange rate changes on cash, cash equivalents, and restricted cash | (6 | ) | (132 | ) | 57 | ||||||
Cash, cash equivalents, and restricted cash | |||||||||||
Net increase/(decrease) | 1,144 | (633 | ) | (2,486 | ) | ||||||
Balance at beginning of period | 1,136 | 1,769 | 4,255 | ||||||||
Balance at end of period | $ | 2,280 | $ | 1,136 | $ | 1,769 | |||||
NON-CASH INVESTING ACTIVITIES: | |||||||||||
Beneficial interest obtained in exchange for securitized trade receivables | $ | — | $ | 938 | $ | 2,519 | |||||
CASH PAID DURING THE PERIOD FOR: | |||||||||||
Interest | $ | 1,306 | $ | 1,322 | $ | 1,269 | |||||
Income taxes | 974 | 543 | 1,206 |
See accompanying notes to the consolidated financial statements.
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The Kraft Heinz Company
Notes to Consolidated Financial Statements
Note 1. Basis of Presentation
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. (“3G Capital”), following their acquisition of H. J. Heinz Company on June 7, 2013.
Principles of Consolidation
The consolidated financial statements include Kraft Heinz and all of our controlled subsidiaries. All intercompany transactions are eliminated.
Reportable Segments
We manage and report our operating results through four segments. We have three reportable segments defined by geographic region: United States, Canada, and Europe, Middle East, and Africa (“EMEA”). Our remaining businesses are combined and disclosed as “Rest of World.” Rest of World comprises two operating segments: Latin America and Asia Pacific (“APAC”).
During the third quarter of 2019, certain organizational changes were announced that will impact our future internal reporting and reportable segments. As a result of these changes, we plan to combine our EMEA, Latin America, and APAC zones to form the International zone. The International zone will be a reportable segment along with the United States and Canada in 2020. We also plan to move our Puerto Rico business from the Latin America zone to the United States zone to consolidate and streamline the management of our product categories and supply chain. These changes will be effective in the first quarter of 2020.
Use of Estimates
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which requires us to make accounting policy elections, estimates, and assumptions that affect the reported amount of assets, liabilities, reserves, and expenses. These policy elections, estimates, and assumptions are based on our best estimates and judgments. We evaluate our policy elections, estimates, and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We believe these estimates to be reasonable given the current facts available. We adjust our policy elections, estimates, and assumptions when facts and circumstances dictate. Market volatility, including foreign currency exchange rates, increases the uncertainty inherent in our estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from estimates. If actual amounts differ from estimates, we include the revisions in our consolidated results of operations in the period the actual amounts become known. Historically, the aggregate differences, if any, between our estimates and actual amounts in any year have not had a material effect on our consolidated financial statements.
Reclassifications
We made reclassifications to certain previously reported financial information to conform to our current period presentation.
Held for Sale
At December 29, 2018, we had classified certain assets and liabilities as held for sale in our consolidated balance sheet primarily relating to the previously announced divestiture of our equity interests in a subsidiary in India and our divestiture of certain assets and operations in Canada, which closed in 2019. At December 28, 2019, the assets and liabilities identified as held for sale in our consolidated balance sheet primarily relate to a business in our Rest of World segment, as well as certain other assets that are held for sale globally. See Note 4, Acquisitions and Divestitures, for additional information.
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Note 2. Significant Accounting Policies
Revenue Recognition:
Our revenues are primarily derived from customer orders for the purchase of our products. We recognize revenues as performance obligations are fulfilled when control passes to our customers. We record revenues net of variable consideration, including consumer incentives and performance obligations related to trade promotions, excluding taxes, and including all shipping and handling charges billed to customers (accounting for shipping and handling charges that occur after the transfer of control as fulfillment costs). We also record a refund liability for estimated product returns and customer allowances as reductions to revenues within the same period that the revenue is recognized. We base these estimates principally on historical and current period experience factors. We recognize costs paid to third party brokers to obtain contracts as expenses as our contracts are generally less than one year.
Advertising, Consumer Incentives, and Trade Promotions:
We promote our products with advertising, consumer incentives, and performance obligations related to trade promotions. Consumer incentives and trade promotions include, but are not limited to, discounts, coupons, rebates, performance-based in-store display activities, and volume-based incentives. Variable consideration related to consumer incentive and trade promotion activities is recorded as a reduction to revenues based on amounts estimated as being due to customers and consumers at the end of a period. We base these estimates principally on historical utilization, redemption rates, and/or current period experience factors. We review and adjust these estimates at least quarterly based on actual experience and other information.
Advertising expenses are recorded in selling, general and administrative expenses (“SG&A”). For interim reporting purposes, we charge advertising to operations as a percentage of estimated full year sales activity and marketing costs. We then review and adjust these estimates each quarter based on actual experience and other information. We recorded advertising expenses of $534 million in 2019, $584 million in 2018, and $629 million in 2017, which represented costs to obtain physical advertisement spots in television, radio, print, digital, and social channels. We also incur other advertising and marketing costs such as shopper marketing, sponsorships, and agency advertisement conception, design, and public relations fees. Total advertising and marketing costs were $1.1 billion in 2019, 2018, and 2017.
Research and Development Expense:
We expense costs as incurred for product research and development within SG&A. Research and development expenses were approximately $112 million in 2019, $109 million in 2018, and $93 million in 2017.
Stock-Based Compensation:
We recognize compensation costs related to equity awards on a straight-line basis over the vesting period of the award, which is generally three to five years, or on a straight-line basis over the requisite service period for each separately vesting portion of the awards. These costs are primarily recognized within SG&A. We estimate expected forfeitures rather than recognizing forfeitures as they occur in determining our equity award compensation costs. We classify equity award compensation costs primarily within general corporate expenses. See Note 11, Employees’ Stock Incentive Plans, for additional information.
Postemployment Benefit Plans:
We maintain various retirement plans for the majority of our employees. These include pension benefits, postretirement health care benefits, and defined contribution benefits. The cost of these plans is charged to expense over an appropriate term based on, among other things, the cost component and whether the plan is active or inactive. Changes in the fair value of our plan assets result in net actuarial gains or losses. These net actuarial gains and losses are deferred into accumulated other comprehensive income/(losses) and amortized within other expense/(income) in future periods using the corridor approach. The corridor is 10% of the greater of the market-related value of the plan’s asset or projected benefit obligation. Any actuarial gains and losses in excess of the corridor are then amortized over an appropriate term based on whether the plan is active or inactive. See Note 12, Postemployment Benefits, for additional information.
Income Taxes:
We recognize income taxes based on amounts refundable or payable for the current year and record deferred tax assets or liabilities for any difference between the financial reporting and tax basis of our assets and liabilities. We also recognize deferred tax assets for temporary differences, operating loss carryforwards, and tax credit carryforwards. Inherent in determining our annual tax rate are judgments regarding business plans, planning opportunities, and expectations about future outcomes. Realization of certain deferred tax assets, primarily net operating loss and other carryforwards, is dependent upon generating sufficient taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods.
We apply a more-likely-than-not threshold to the recognition and derecognition of uncertain tax positions. Accordingly, we recognize the amount of tax benefit that has a greater than 50 percent likelihood of being ultimately realized upon settlement.
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Future changes in judgment related to the expected ultimate resolution of uncertain tax positions will affect our results in the quarter of such change.
We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. When assessing the need for valuation allowances, we consider future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, we would adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding adjustment to our provision for/(benefit from) income taxes. The resolution of tax reserves and changes in valuation allowances could be material to our results of operations for any period, but is not expected to be material to our financial position.
Common Stock and Preferred Stock Dividends:
Dividends are recorded as a reduction to retained earnings. When we have an accumulated deficit, dividends are recorded as a reduction of additional paid-in capital.
Cash and Cash Equivalents:
Cash equivalents include demand deposits with banks and all highly liquid investments with original maturities of three months or less. Cash and cash equivalents that are legally restricted as to withdrawal or usage is classified in other current assets or other non-current assets, as applicable, on the consolidated balance sheets.
Inventories:
Inventories are stated at the lower of cost or net realizable value. We value inventories primarily using the average cost method.
Property, Plant and Equipment:
Property, plant and equipment are stated at historical cost and depreciated on the straight-line method over the estimated useful lives of the assets. Machinery and equipment are depreciated over periods ranging from three years to 20 years and buildings and improvements over periods up to 40 years. Capitalized software costs are included in property, plant and equipment and amortized on a straight-line basis over the estimated useful lives of the software, which do not exceed seven years. We review long-lived assets for impairment when conditions exist that indicate the carrying amount of the assets may not be fully recoverable. Such conditions could include significant adverse changes in the business climate, current-period operating or cash flow losses, significant declines in forecasted operations, or a current expectation that an asset group will be disposed of before the end of its useful life. We perform undiscounted operating cash flow analyses to determine if an impairment exists. When testing for impairment of assets held for use, we group assets at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, the loss is calculated based on estimated fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
Goodwill and Intangible Assets:
We maintain 19 reporting units, 11 of which comprise our goodwill balance. Our indefinite-lived intangible asset balance primarily consists of a number of individual brands. We test our reporting units and brands for impairment annually as of the first day of our second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit or brand is less than its carrying amount. Such events and circumstances could include a sustained decrease in our market capitalization, increased competition or unexpected loss of market share, increased input costs beyond projections (for example due to regulatory or industry changes), disposals of significant brands or components o