UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 30, 2017
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from __________ to __________
Commission File Number 001-37482
The Kraft Heinz Company
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 46-2078182 (I.R.S. Employer Identification No.) | |
One PPG Place, Pittsburgh, Pennsylvania (Address of Principal Executive Offices) | 15222 (Zip Code) | |
Registrant’s telephone number, including area code: (412) 456-5700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of exchange on which registered | |
Common stock, $0.01 par value | 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 x No o
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 o No x
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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 x | Accelerated filer o | |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o | Emerging growth company o |
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
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 $52 billion. As of February 10, 2018, there were 1,218,801,890 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 April 23, 2018 are incorporated by reference into Part III hereof.
The Kraft Heinz Company
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.
Forward-Looking Statements
This Annual Report on Form 10-K contains a number of forward-looking statements. Words such as “anticipate,” “expect,” “improve,” “assess,” “remain,” “evaluate,” “grow,” “will,” “plan,” and variations of such words and similar expressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our plans, segment changes, growth, taxes, cost savings, impacts of accounting guidance, 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 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; changes in the retail landscape or the loss of key retail customers; our ability to maintain, extend and expand our reputation and brand image; the impacts of our international operations; our ability to leverage our brand value; our ability to predict, identify and interpret changes in consumer preferences and demand; our ability to drive revenue growth in our key product categories, increase our market share, or add products; an impairment of the carrying value of goodwill or other indefinite-lived intangible assets; volatility in commodity, energy and other input costs; changes in our management team or other key personnel; our ability to realize the anticipated benefits from our cost savings initiatives; changes in relationships with significant customers and suppliers; the execution of our international expansion strategy; tax law changes or interpretations; legal claims or other regulatory enforcement actions; product recalls or product liability claims; unanticipated business disruptions; our ability to complete or realize the benefits from potential and completed acquisitions, alliances, divestitures or joint ventures; economic and political conditions in the United States and in various other nations in which we operate; the volatility of capital markets; increased pension, labor and people-related expenses; volatility in the market value of all or a portion of the derivatives we use; exchange rate fluctuations; risks associated with information technology and systems, including service interruptions, misappropriation of data or breaches of security; our inability to protect intellectual property rights; impacts of natural events in the locations in which we or our customers, suppliers or regulators operate; our indebtedness and ability to pay such indebtedness; our ownership structure; the impact of future sales of our common stock in the public markets; our ability to continue to pay a regular dividend; changes in laws and regulations; restatements of our consolidated financial statements; and other factors. For additional information on these and other factors that could affect our forward-looking statements, see “Risk Factors” below in this Annual Report on Form 10-K. 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
Kraft Heinz is one of the largest food and beverage companies in the world, with sales in approximately 190 countries and territories. 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, under a host of iconic brands including Heinz, Kraft, Oscar Mayer, Philadelphia, Velveeta, Lunchables, Planters, Maxwell House, Capri Sun, Ore-Ida, Kool-Aid, Jell-O. A globally recognized producer of delicious foods, we provide products for all occasions whether at home, in restaurants or on the go. As of December 30, 2017, we had assets of $120.2 billion. Our common stock is listed on The NASDAQ Global Select Market (“NASDAQ”) under the ticker symbol “KHC”.
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 and H. J. Heinz Company changed its name to Kraft Heinz Foods Company. While we were organized as a Delaware corporation in 2013 (as Heinz), both Kraft and Heinz each had been pioneers in the food industry for over 100 years.
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 (the “2013 Merger”).
See Note 1, Background and Basis of Presentation, and Note 2, Merger and Acquisition, to the consolidated financial statements for additional information on the 2015 Merger.
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. Our remaining businesses are combined and disclosed as “Rest of World”. Rest of World is comprised of two operating segments: Latin America; and Asia Pacific, Middle East, and Africa (“AMEA”).
In the third quarter of 2017, we announced our plans to reorganize certain of our international businesses to better align our global geographies. These plans include moving our Middle East and Africa businesses from the AMEA segment into the Europe segment, forming the Europe, Middle East, and Africa (“EMEA”) segment. The remaining AMEA businesses will become the Asia Pacific (“APAC”) segment, which will remain in Rest of World. We expect these changes to become effective in the first quarter of 2018. As a result, we expect to restate our Europe and Rest of World segments to reflect these changes for historical periods presented in the first quarter of 2018.
See Note 19, Segment Reporting, to the consolidated financial statements for our geographic financial information by segment.
Net Sales by Product Category
In the first quarter of 2017, we reorganized the products within our product categories to reflect how we manage our business. We have reflected this change for all historical periods presented. The product categories that contributed 10% or more to consolidated net sales in any of the periods presented were:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | ||||||
Condiments and sauces | 25 | % | 24 | % | 32 | % | ||
Cheese and dairy | 21 | % | 21 | % | 15 | % | ||
Ambient meals | 9 | % | 9 | % | 10 | % | ||
Frozen and chilled meals | 10 | % | 10 | % | 12 | % | ||
Meats and seafood | 10 | % | 10 | % | 8 | % | ||
We completed the 2015 Merger on July 2, 2015. As a result, 2016 was the first full year of combined Kraft and Heinz results, while 2015 included a full year of Heinz results and post-2015 Merger results of Kraft. The year-over-year fluctuations in the percentages between 2015 and 2016 are primarily driven by including Kraft’s results.
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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 2017, approximately 22% of our net sales in 2016, and approximately 20% of our net sales in 2015.
Additionally, we have significant customers in different regions around the world; however, none of these customers individually are material to our consolidated business. In 2017, the five largest customers in our United States segment accounted for approximately 48% of United States segment net sales, the five largest customers in our Canada segment accounted for approximately 72% of Canada segment net sales, and the five largest customers in our Europe segment accounted for approximately 31% of our Europe segment net sales.
Raw Materials and Packaging
We manufacture (and contract for the manufacture of) our products from a wide variety of raw food 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, wheat and other goods to manufacture our products. In addition, we purchase and use significant quantities of resins 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/or 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 and agricultural 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, 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.
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 generic products, in addition to retailer brands, wholesalers, and cooperatives. We compete primarily on the basis of product quality and innovation, brand recognition and loyalty, service, the ability to identify and satisfy consumer preferences, the introduction of new products and the effectiveness of our advertising campaigns and marketing programs, distribution, shelf space, merchandising support, and price. Improving our market position or introducing new products requires substantial advertising and promotional expenditures.
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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 2017 were:
Majority Owned and Licensed Trademarks | ||
United States | Kraft, Oscar Mayer, Heinz, Philadelphia, Lunchables, Velveeta, Planters, Maxwell House, Capri Sun*, Ore-Ida, Kool-Aid, Jell-O | |
Canada | Kraft, Heinz, Philadelphia, Cracker Barrel, P’Tit Cheese, Maxwell House, Tassimo*, Classico | |
Europe | Heinz, Plasmon, Pudliszki, Honig, HP, Benedicta | |
Rest of World | Heinz, ABC, Master, Quero, Golden Circle, Kraft, Wattie's, Glucon D, Complan | |
*Used under license
We sell some products under brands we license from third parties, including 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 our agreements with Mondelēz International, Inc. (“Mondelēz International”), 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 following the spin-off of Kraft from Mondelēz International in 2012.
We 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 basic 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.
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:
• | growth through product improvements and renovation, innovation, and line extensions, |
• | uncompromising product safety and quality, |
• | superior customer satisfaction, and |
• | cost reduction. |
Research and development expense was approximately $93 million in 2017, $120 million in 2016, and $105 million in 2015.
Seasonality
Although crops constituting some of our raw food ingredients are harvested on a seasonal basis, most 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. These factors influence our quarterly sales, operating income, and cash flows.
Employees
We had approximately 39,000 employees as of December 30, 2017.
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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, occupational safety and health practices, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as laws and regulations administered by government entities and agencies outside the United States in markets in which our products are manufactured, distributed or sold. In the U.S., 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 North America, 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.
Environmental Regulation
Our activities throughout the world are highly regulated and subject to government oversight. 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 and legislation) related to our current operations and certain closed, inactive, or divested operations for which we retain liability. We do not currently expect these to have a material effect on our earnings or financial condition.
As of December 30, 2017, 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.
Executive Officers
The following are our executive officers as of February 10, 2018:
Name | Age | Title | ||
Bernardo Hees | 48 | Chief Executive Officer | ||
David Knopf | 29 | Executive Vice President and Chief Financial Officer | ||
Paulo Basilio | 43 | President of U.S. Commercial Business | ||
Pedro Drevon | 35 | Zone President of Latin America | ||
Rashida La Lande | 44 | Senior Vice President, Global General Counsel and Corporate Secretary | ||
Rafael Oliveira | 43 | Zone President of EMEA | ||
Eduardo Pelleissone | 44 | Executive Vice President of Global Operations | ||
Carlos Piani | 44 | Zone President of Canada | ||
Rodrigo Wickbold | 41 | Zone President of APAC | ||
Bernardo Hees became Chief Executive Officer upon the closing of the 2015 Merger. He had previously served as Chief Executive Officer of Heinz since June 2013. Previously, Mr. Hees served as Chief Executive Officer of Burger King Worldwide Holdings, Inc., a global fast food restaurant chain, from September 2010 to June 2013 and Burger King Worldwide, Inc. from June 2012 to June 2013 and as Chief Executive Officer of América Latina Logística (“ALL”), a logistics company, from January 2005 to September 2010. Mr. Hees has also been a partner at 3G Capital since July 2010.
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David Knopf became Executive Vice President and Chief Financial Officer in October 2017. He had previously served as Vice President, Category Head of Planters Business since August 2016. Prior to that role, Mr. Knopf served as Vice President of Finance, Head of Global Budget & Business Planning, Zero-Based Budgeting, and Financial & Strategic Planning from July 2015 to August 2016. Prior to joining Kraft Heinz in July 2015, Mr. Knopf served in various roles at 3G Capital, including as an associate partner. Before joining 3G Capital in October 2013, Mr. Knopf served in various roles at Onex Partners, a private equity firm, and Goldman Sachs, a global investment banking, securities, and investment management firm. Mr. Knopf has also been a partner of 3G Capital since July 2015.
Paulo Basilio assumed his current role as President of the U.S. Commercial Business in October 2017. 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 ALL from September 2010 to June 2012, after having served in various roles at ALL, including Chief Operating Officer, Chief Financial Officer, and Analyst. Mr. Basilio has also been a partner of 3G Capital since July 2012.
Pedro Drevon assumed his current role as Zone President of Latin America in October 2017. Previously he served as Managing Director for Kraft Heinz Brazil since August 2015. Prior to joining Kraft Heinz in 2015, Mr. Drevon served in various capacities at 3G Capital. Before joining 3G Capital in 2008, Mr. Drevon served in various roles at Banco BBM, a financial advisory and wealth management firm. Mr. Drevon has also been a partner of 3G Capital since January 2011.
Rashida La Lande joined Kraft Heinz as Senior Vice President, Global General Counsel and Corporate Secretary in January 2018. Prior to joining Kraft Heinz, Ms. La Lande was a partner at the law firm of Gibson, Dunn & Crutcher, where she advised corporations and their boards, primarily in the areas of mergers and acquisitions, leveraged buyouts, private equity deals, and joint ventures. During her nearly 20-year career at Gibson, Dunn & Crutcher, she represented companies and private equity sponsors in the consumer products, retail, financial services, and technology industries.
Rafael Oliveira assumed his current role as Zone President of EMEA in October 2016 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, a global investment banking, securities, and investment management firm.
Eduardo Pelleissone assumed his current role as Executive Vice President of Global Operations upon the closing of the 2015 Merger and had previously held the same role at Heinz since July 2013. Prior to joining Heinz, Mr. Pelleissone was Chief Executive Officer of ALL from May 2012 to June 2013. Prior to assuming that role, Mr. Pelleissone held the roles of Chief Operating Officer from July 2011 to 2012 and Commercial Vice President of the Agriculture Segment at ALL from 2004 to 2011.
Carlos Piani was appointed Zone President of Canada in September 2015. Prior to joining Kraft Heinz, Mr. Piani served as Chief Executive Officer of PDG Realty S.A. Empreendimentos e Participacoes, a real estate company, from August 2012 to August 2015. Previously, he served as Co-Head of Private Equity of Vinci Partners, an independent asset management firm, from April 2010 to August 2012, as Chief Executive Officer of Companhia Energetica do Maranhao (“CEMAR”), an electricity distribution company, from March 2006 to April 2010, and as Chief Executive Officer of Equatorial Energia S/A, CEMAR’s controlling shareholder, from March 2007 to April 2010.
Rodrigo Wickbold assumed his current role as Zone President of APAC in January 2018 after serving as Chief Marketing Officer of APAC since January 2016. Prior to joining Kraft Heinz in January 2016, Mr. Wickbold served in various marketing and business leadership roles at Unilever, a consumer products company, since 2000, including as Global Senior Brand Manager - Skin Care.
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 (the “Exchange Act”) are available free of charge on our website as soon as possible after we electronically file them with, or furnish them to, the SEC. You can also read, access and copy any document that we file, including this Annual Report on Form 10-K, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Call the SEC at 1-800-SEC-0330 for information on the operation of the Public Reference Room. 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.
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Item 1A. Risk Factors.
We operate in a highly competitive industry.
The food and beverage industry is highly competitive across all of our product offerings. 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 consumer preferences.
We may need to reduce our prices in response to competitive and customer pressures. These pressures may also restrict our ability to increase prices in response to commodity and other cost increases. Failure to effectively assess, timely change and set proper pricing or trade incentives may negatively impact the achievement of our objectives.
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 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 suffer.
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 position 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 the scale to develop supply chains that permit them to operate with reduced inventories or to develop and market their own retailer brands. 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.
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. 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. Moreover, adverse publicity about legal or regulatory action against us, our quality and safety, our environmental or social impacts, 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.
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 anticipate consumer preferences, 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.
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Our international operations subject us to additional risks and costs and may cause our profitability to decline.
We are a global company with sales in approximately 190 countries and territories; approximately 30% of our 2017 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 interpretation, or tax audit implications; |
• | the imposition of increased or new tariffs, quotas, trade barriers or similar restrictions on our sales or regulations, taxes or policies that might negatively affect our sales; |
• | 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 and positions that we take to hedge such volatility; |
• | changing labor conditions and difficulties in staffing our operations; |
• | greater risk of uncollectible accounts and longer collection cycles; and |
• | 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 regional 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.
We must leverage our brand value to compete against retailer brands and other economy brands.
In nearly all of our product categories, we compete with branded products as well as retailer and other economy brands, 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 retailer or other economy brands change in favor of competitors’ products or if consumers perceive this type of change. If consumers prefer retailer or other economy brands, 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.
7
Our financial 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. 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 fads, mid-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 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.
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.
An impairment of the carrying value of goodwill or other indefinite-lived intangible assets could negatively affect our consolidated operating results.
We test goodwill and indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. We performed our annual impairment testing in the second quarter of 2017. The first step of the goodwill impairment test compares the reporting unit’s estimated fair value with its carrying value. If the carrying value of a reporting unit’s net assets exceeds its fair value, the second step would be applied to measure the difference between the carrying value and implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, the goodwill would be considered impaired and would be reduced to its implied fair value. We test indefinite-lived intangible assets for impairment by comparing the fair value of each intangible asset with its carrying value. If the carrying value exceeds fair value, the intangible asset would be considered impaired and would be reduced to its fair value.
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 indefinite-lived intangible assets requires us to make assumptions and estimates regarding our future plans, as well as industry and economic conditions. These assumptions and estimates include projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors. If current expectations of future growth rates are not met or market factors outside of our control, such as discount rates, change significantly, then one or more reporting units or intangible assets might become impaired in the future. As goodwill and intangible assets associated with recently acquired businesses are recorded on the balance sheet at their estimated acquisition date fair values, those amounts are more susceptible to an impairment risk if business operating results or macroeconomic conditions deteriorate. Additionally, recently impaired intangible assets can also be more susceptible to future impairment as they are recorded on the balance sheet at their recently estimated fair values.
8
An impairment of the carrying value of goodwill or other indefinite-lived intangible assets could negatively affect our operating results or net worth.
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, soybean and vegetable oils, sugar and other sweeteners, corn products, tomatoes, cucumbers, potatoes, onions, other fruits and vegetables, spices, flour, and wheat to manufacture our products. In addition, we purchase and use significant quantities of resins, cardboard, glass, plastic, metal, paper, fiberboard, and other materials to package our products and we use other inputs, such as water and natural gas, 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, 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. 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.
We rely on our management team and other key personnel.
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. Any such loss or failure could adversely affect our product sales, financial condition, and operating results.
We may be unable to realize the anticipated benefits from 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 Integration Program (as defined below), that we believe are important to position our business for future success and growth. We have evaluated changes to our organization 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 our 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 be efficient in executing our 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 on those areas with the most potential return on investment. If we are unable to realize the anticipated benefits from our efforts, we could be cost disadvantaged in the marketplace, and our competitiveness, production, and profitability could be adversely affected.
9
Changes in our relationships with significant customers or suppliers could adversely impact us.
We derive significant portions of our sales from certain significant customers (see Sales and Customers within Item 1, Business, of this report). 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, the financial condition of such customers and suppliers is affected in large part by conditions and events that are beyond our control. A significant deterioration in the financial condition of significant customers and suppliers could materially and adversely affect our product sales, financial condition, and operating results.
We may not be able to successfully execute our international expansion strategy.
We plan to drive additional growth and profitability through international markets. Consumer demands, behaviors, tastes and purchasing trends may differ in international 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 foreign 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. There can be no assurance that we will successfully complete any planned international expansion or that any new business will be profitable or meet our expectations.
Changes in tax laws and interpretations could adversely affect our business.
We are subject to income and other taxes in the U.S. 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 U.S., which represents a 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. We are still assessing the impact of the U.S. Tax Reform, and while a number of impacts are anticipated to be positive, certain provisions may have adverse or uncertain effects. 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” could impact our effective tax rate. It is not currently possible to accurately determine the potential impact of these proposed or future changes, but these changes could have a material impact on our business.
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, increases in expenses not deductible for tax, including impairment of goodwill in connection with acquisitions, 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.
Compliance with changes in laws, regulations, and related interpretations could impact our business.
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, and environmental matters, as well as health and safety practices. Government authorities regularly change laws and regulations and their interpretations. 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.
10
Although we have implemented policies and procedures designed to ensure compliance with existing laws and regulations, there can be no assurance that courts or regulators will agree with our interpretations or that our employees, contractors, or agents will not violate our policies and procedures. Moreover, a failure to maintain effective control processes could lead to violations, unintentional or otherwise, of laws and regulations. Legal claims or regulatory enforcement actions arising out of our failure or alleged failure to comply with applicable laws and regulations could subject us to civil and criminal penalties that could materially and adversely affect our product sales, reputation, financial condition, and operating results. In addition, the costs and other effects of defending potential and pending litigation and administrative actions against us may be difficult to determine and could adversely affect our financial condition and operating results.
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 could decide to, or be required to, recall products due to suspected or confirmed product contamination, adulteration, product mislabeling or misbranding, tampering, 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.
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 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, fire or explosion, political unrest, terrorism, generalized labor unrest, or health pandemics, could damage or disrupt our operations or our suppliers’ or co-manufacturers’ 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.
We may not successfully identify or complete strategic acquisitions, alliances, divestitures or joint ventures.
From time to time, we may evaluate acquisition candidates, alliances, or joint ventures that may strategically fit our business objectives or we 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, the European Union, and other jurisdictions, and we may be required to obtain the approval of acquisition and joint venture transactions by competition authorities, as well as to satisfy other legal requirements.
To the extent we undertake acquisitions, alliances, joint ventures, 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.
11
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 United Kingdom's impending withdrawal from the European Union (commonly referred to as “Brexit”) and changes to major international trade arrangements (e.g., the North American Free Trade Agreement), could negatively impact our operations and sales. 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 could materially and adversely affect our product sales, financial condition, and operating results. For further information on Venezuela, see Note 13, Venezuela - Foreign Currency and Inflation, to the consolidated financial statements.
Volatility of capital markets or macro-economic factors could adversely affect our business.
Changes in financial and capital markets, including market disruptions, limited liquidity, and interest rate volatility, may increase the cost of financing as well as the risks of refinancing maturing debt. In addition, our borrowing costs can be affected by short and long-term ratings assigned by rating organizations. A decrease in these 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.
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 and increased 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.
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.
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.
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 operating results and net income.
We use commodity futures and options to partially hedge the price of certain input costs, including dairy products, coffee beans, meat products, wheat, corn products, soybean oils, sugar and natural gas. Changes in the values of these derivatives are currently recorded in net income, resulting in volatility in both gross profits and net income. We report 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 report 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. We may experience volatile earnings as a result of these accounting treatments.
12
Our net sales and net income may be exposed to 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, and Chinese renminbi. Since our consolidated financial statements are denominated 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.
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 cyber-attacks, 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.
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.
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, 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, and trade secret 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 obtain 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.
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.
13
Our results of operations could be affected by natural events in the locations in which we or our customers, suppliers or regulators operate.
We may 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, and regulators. Natural disasters or other disruptions at any of our facilities or our suppliers’ facilities may impair or delay the delivery of our products. Influenza or other pandemics 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, we cannot provide any assurance that such insurance will compensate us for any losses incurred as a result of natural or other disasters. 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.
Our level of indebtedness could adversely affect our business.
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, 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, 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 substantially all 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.
The creditors who hold our debt could also 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, we may in the future need to obtain waivers from the required creditors under our indebtedness instruments to avoid being in default. If we breach the covenants under our indebtedness instruments and seek a waiver, we may not be able to obtain a waiver from the required creditors. If this occurs, we would be in default under our indebtedness instruments, the creditors could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.
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The Sponsors have substantial control over us and may have conflicts of interest with us in the future.
The Sponsors own approximately 51% of our common stock. Six of our 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, some of our executive officers, including Bernardo Hees, our Chief Executive Officer, are partners of 3G Capital, one of the Sponsors. 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 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, incurrence of additional indebtedness, the implementation of stock repurchase programs and the decision of whether or not to declare 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.
Future 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, 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.
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 the closing of the 2015 Merger, registrable shares represented approximately 51% of our outstanding common stock on a fully diluted basis. 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, sales of a large number of registrable shares may be made upon registration of such shares with the SEC in accordance with the terms of the registration rights agreement. Registration and sales of our common stock effected pursuant to the registration rights agreement will increase the number of shares being sold 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 is subject to the discretion of the Board of Directors and may be limited by our 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 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, and other factors the Board of Directors deems relevant. The Board of Directors may, in its sole discretion, 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.
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While we have remediated the previously-identified material weakness in our internal control over financial reporting, we may identify other material weaknesses in the future.
In November 2017, we restated our consolidated financial statements for the quarters ended April 1, 2017 and July 1, 2017 in order to correctly classify cash receipts from the payments on sold receivables (which are cash receipts on the underlying trade receivables that have already been securitized) to cash provided by investing activities (from cash provided by operating activities) within our condensed consolidated statements of cash flows. In connection with these restatements, management identified a material weakness in our internal control over financial reporting related to the misapplication of Accounting Standards Update 2016-15. Specifically, we did not maintain effective controls over the adoption of new accounting standards, including communication with the appropriate individuals in coming to our conclusions on the application of new accounting standards. As a result of this material weakness, our management concluded that we did not maintain effective internal control over financial reporting as of April 1, 2017 and July 1, 2017. While we have remediated the material weakness and our management has determined that our disclosure controls and procedures were effective as of December 30, 2017, there can be no assurance that our controls will remain adequate. The effectiveness of our internal control over financial reporting is subject to various inherent limitations, including judgments used in decision-making, the nature and complexity of the transactions we undertake, assumptions about the likelihood of future events, the soundness of our systems, cost limitations, and other limitations. If other material weaknesses or significant deficiencies in our internal control are discovered or occur in the future or we otherwise must restate our financial statements, it could materially and adversely affect our business and results of operations or financial condition, restrict our ability to access the capital markets, require us to expend significant resources to correct the weaknesses or deficiencies, subject us to fines, penalties, investigations or judgments, harm our reputation, or otherwise cause a decline in investor confidence.
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 30, 2017, 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 30, 2017 was:
Owned | Leased | ||
United States | 41 | 1 | |
Canada | 2 | — | |
Europe | 11 | — | |
Rest of World | 26 | 2 | |
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.
Item 3. Legal Proceedings.
We are routinely involved in legal proceedings, claims, and governmental inquiries, inspections or investigations (“Legal Matters”) arising in the ordinary course of our business. While we cannot predict with certainty the results of Legal Matters in which we are currently involved or may in the future be involved, we do not expect that the ultimate costs to resolve any of the Legal Matters that are currently pending will have a material adverse effect on our financial condition or results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
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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 10, 2018, there were approximately 53,000 holders of record of our common stock.
Our stock began publicly trading on July 6, 2015. Our quarterly highest and lowest market prices and dividends declared are:
2017 Quarters | 2016 Quarters | ||||||||||||||||||||||||||||||
First | Second | Third | Fourth | First | Second | Third | Fourth | ||||||||||||||||||||||||
Market price-high | $ | 97.77 | $ | 93.88 | $ | 90.38 | $ | 82.48 | $ | 79.16 | $ | 89.40 | $ | 90.54 | $ | 90.15 | |||||||||||||||
Market price-low | 85.41 | 85.45 | 77.40 | 75.21 | 68.18 | 76.64 | 84.25 | 79.69 | |||||||||||||||||||||||
Dividends declared | 0.60 | 0.60 | 0.625 | 0.625 | 0.575 | 0.575 | 0.60 | 0.60 | |||||||||||||||||||||||
Comparison of Cumulative Total Return
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 Products, which we consider to be our peer group. This graph covers the period from July 6, 2015 (the first day our common stock began trading on NASDAQ) through December 29, 2017 (the last trading day of our fiscal year). 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 Products | |||||||||
July 6, 2015 | $ | 100.00 | $ | 100.00 | $ | 100.00 | |||||
December 31, 2015 | 102.07 | 99.85 | 107.48 | ||||||||
December 30, 2016 | 125.99 | 111.79 | 117.49 | ||||||||
December 29, 2017 | 115.44 | 136.20 | 118.95 | ||||||||
Companies included in the S&P Consumer Staples Food Products index change periodically. During 2017, Mead Johnson Nutrition Company was removed from the index, therefore it is excluded from the table and chart above.
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 30, 2017
Our share repurchase activity in the three months ended December 30, 2017 was:
Total Number of Shares(a) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(b) | Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||||
10/1/2017 - 11/4/2017 | 648 | $ | 77.25 | — | $ | — | ||||||||
11/5/2017 - 12/2/2017 | — | — | — | — | ||||||||||
12/3/2017 - 12/30/2017 | 1,428 | 80.46 | — | — | ||||||||||
For the Three Months Ended December 30, 2017 | 2,076 | — | ||||||||||||
(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 RSUs, 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.
Periods Presented:
On June 7, 2013, H. J. Heinz Company was acquired by Heinz (formerly known as Hawk Acquisition Holding Corporation), a Delaware corporation controlled by the Sponsors, pursuant to the Agreement and Plan of Merger, dated February 13, 2013, as amended by the Amendment to Agreement and Plan of Merger, dated March 4, 2013, by and among H. J. Heinz Company, Heinz, and Hawk Acquisition Sub, Inc. (“Hawk”).
The 2013 Merger established a new accounting basis for Heinz. Accordingly, the consolidated financial statements present both predecessor and successor periods, which relate to the accounting periods preceding and succeeding the completion of the 2013 Merger. The predecessor and successor periods are separated by a vertical line to highlight the fact that the financial information for such periods has been prepared under two different historical-cost bases of accounting.
Additionally, on October 21, 2013, our Board of Directors approved a change in our fiscal year-end from the Sunday closest to April 30 to the Sunday closest to December 31. In 2013, as a result of the change in fiscal year-end, the 2013 Merger, and the creation of Hawk, there are three 2013 reporting periods as described below.
The “Successor” (Heinz, renamed to The Kraft Heinz Company at the closing of the 2015 Merger) period includes:
• | The consolidated financial statements for the year ended December 30, 2017 (a 52-week period, including a full year of Kraft Heinz results); |
• | The consolidated financial statements for the year ended December 31, 2016 (a 52-week period, including a full year of Kraft Heinz results); |
• | The consolidated financial statements for the year ended January 3, 2016 (a 53-week period, including a full year of Heinz results and post-2015 Merger results of Kraft); |
• | The consolidated financial statements for the year ended December 28, 2014 (a 52-week period, including a full year of Heinz results); and |
•The period from February 8, 2013 through December 29, 2013 (the “2013 Successor Period”), reflecting:
▪ | The creation of Hawk on February 8, 2013 and the activity from February 8, 2013 to June 7, 2013, which related primarily to the issuance of debt and recognition of associated issuance costs and interest expense; and |
▪ | All activity subsequent to the 2013 Merger. Therefore, the 2013 Successor Period includes 29 weeks of operating activity (June 8, 2013 to December 29, 2013). We indicate in the selected financial data table the weeks of operating activities in this period. |
The “Predecessor” (H. J. Heinz Company) period includes, but is not limited to:
• | The consolidated financial statements of H. J. Heinz Company prior to the 2013 Merger on June 7, 2013, which includes the period from April 29, 2013 through June 7, 2013 (the “2013 Predecessor Period”); this represents six weeks of activity from April 29, 2013 through the 2013 Merger; and |
• | The consolidated financial statements of H. J. Heinz Company for the fiscal year from April 30, 2012 to April 28, 2013 (“Fiscal 2013”). |
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Selected Financial Data:
The following table presents selected consolidated financial data for 2017, 2016, 2015, 2014, the 2013 Successor Period, the 2013 Predecessor Period, and Fiscal 2013.
Successor | Predecessor (H. J. Heinz Company) | ||||||||||||||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks)(a) | January 3, 2016 (53 weeks) | December 28, 2014 (52 weeks) | February 8 - December 29, 2013 (29 weeks) | April 29 - June 7, 2013 (6 weeks) | April 28, 2013 (52 weeks) | |||||||||||||||||||||
(in millions, except per share data) | |||||||||||||||||||||||||||
Period Ended: | |||||||||||||||||||||||||||
Net sales(b)(d) | $ | 26,232 | $ | 26,487 | $ | 18,338 | $ | 10,922 | $ | 6,240 | $ | 1,113 | $ | 11,529 | |||||||||||||
Income/(loss) from continuing operations(b) | 10,990 | 3,642 | 647 | 672 | (66 | ) | (191 | ) | 1,102 | ||||||||||||||||||
Income/(loss) from continuing operations attributable to common shareholders(b) | 10,999 | 3,452 | (266 | ) | (63 | ) | (1,118 | ) | (194 | ) | 1,088 | ||||||||||||||||
Income/(loss) from continuing operations per common share(b): | |||||||||||||||||||||||||||
Basic | 9.03 | 2.84 | (0.34 | ) | (0.17 | ) | (2.97 | ) | (0.60 | ) | 3.39 | ||||||||||||||||
Diluted | 8.95 | 2.81 | (0.34 | ) | (0.17 | ) | (2.97 | ) | (0.60 | ) | 3.37 | ||||||||||||||||
As of: | |||||||||||||||||||||||||||
Total assets(d) | 120,232 | 120,480 | 122,973 | 36,571 | 38,681 | NA | 12,920 | ||||||||||||||||||||
Long-term debt(c)(d) | 28,333 | 29,713 | 25,151 | 13,358 | 14,326 | NA | 3,830 | ||||||||||||||||||||
Redeemable preferred stock | — | — | 8,320 | 8,320 | 8,320 | NA | — | ||||||||||||||||||||
Cash dividends per common share | 2.45 | 2.35 | 1.70 | — | — | — | 2.06 | ||||||||||||||||||||
(a) | 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. |
(b) | Amounts exclude the operating results and any associated impairment charges and losses on sale related to the Company's Shanghai LongFong Foods business in China and U.S. Foodservice frozen desserts business, which were divested in Fiscal 2013. |
(c) | Amounts exclude the current portion of long-term debt. Additionally, amounts include interest rate swap hedge accounting adjustments of $123 million at April 28, 2013. There were no interest rate swaps requiring such hedge accounting adjustments at December 30, 2017, December 31, 2016, January 3, 2016, December 28, 2014, or December 29, 2013. |
(d) | The increases in net sales, total assets, and long-term debt from December 28, 2014 to January 3, 2016 reflect the impact of the 2015 Merger. See Note 2, Merger and Acquisition, to the consolidated financial statements for additional information. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and related notes contained in Item 8, Financial Statements and Supplementary Data.
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 Europe. Our remaining businesses are combined and disclosed as “Rest of World”. Rest of World is comprised of two operating segments: Latin America and AMEA.
In the third quarter of 2017, we announced our plans to reorganize certain of our international businesses to better align our global geographies. These plans include moving our Middle East and Africa businesses from the AMEA operating segment into the EMEA operating segment. The remaining AMEA businesses will become the APAC operating segment. We currently expect these changes to become effective in the first quarter of our fiscal year 2018. As a result, we expect to restate our Europe and Rest of World segments to reflect these changes for historical periods presented as of March 31, 2018.
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See Note 19, Segment Reporting, to the consolidated financial statements for our financial information by segment.
Items Affecting Comparability of Financial Results
The 2015 Merger:
We completed the 2015 Merger on July 2, 2015. As a result, 2016 was the first full year of combined Kraft and Heinz results, while 2015 included a full year of Heinz results and post-2015 Merger results of Kraft. For comparability, we disclose in this report certain unaudited pro forma condensed combined financial information, which presents 2015 as if the 2015 Merger had been consummated on December 30, 2013, the first business day of our 2014 fiscal year, and combines the historical results of Heinz and Kraft. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information section at the end of this item for additional information.
See Note 1, Background and Basis of Presentation, to the consolidated financial statements for additional information related to the 2015 Merger.
Integration and Restructuring Expenses:
In 2017, we substantially completed our multi-year program announced following the 2015 Merger (the “Integration Program”), for which we expect to incur cumulative pre-tax costs of approximately $2.1 billion. Approximately 60% of these costs will be cash expenditures. As of December 30, 2017, we have incurred cumulative pre-tax costs of $2,055 million related to the Integration Program. These costs primarily included severance and employee benefit costs (including cash and non-cash severance), costs to exit facilities (including non-cash costs such as accelerated depreciation), and other costs incurred as a direct result of integration activities related to the 2015 Merger.
Total expenses related to our restructuring activities, including the Integration Program, were $457 million in 2017, $1,012 million in 2016, and $1,023 million in 2015. Integration Program costs included in these totals were $339 million in 2017, $887 million in 2016, and $829 million in 2015.
We anticipate cumulative capital expenditures of approximately $1.4 billion related to the Integration Program. As of December 30, 2017, we have incurred $1.3 billion in capital expenditures since the inception of the Integration Program. The Integration Program was designed to reduce costs, integrate, and optimize our combined organization. Since the inception of the Integration Program, our cumulative pre-tax savings achieved are approximately $1,725 million, primarily benefiting the United States and Canada segments.
See Note 3, Integration and Restructuring Expenses, to the consolidated financial statements for additional information.
U.S. Tax Reform:
On December 22, 2017, the Tax Cuts and Jobs Act (“U.S. Tax Reform”) was enacted by the U.S. federal government. The legislation significantly changed U.S. tax law by, among other things, lowering the federal corporate tax rate from 35.0% to 21.0%, effective January 1, 2018, implementing a territorial tax system, and imposing a one-time toll charge on deemed repatriated earnings of foreign subsidiaries as of December 30, 2017. The two material items that impacted us in 2017 were the corporate tax rate reduction and the one-time toll charge. While the corporate tax rate reduction is effective January 1, 2018, we accounted for this anticipated rate change in 2017, the period of enactment.
We have estimated the provisional tax impacts related to the toll charge, certain components of the revaluation of deferred tax assets and liabilities, including depreciation and executive compensation, and the change in our indefinite reinvestment assertion. As a result, we recognized a net tax benefit of approximately $7.0 billion, including a reasonable estimate of our deferred income tax benefit of approximately $7.5 billion related to the corporate rate change, which was partially offset by a reasonable estimate of $312 million for the toll charge and approximately $125 million for other tax expenses, including a change in our indefinite reinvestment assertion.
See Critical Accounting Policies within this item and Note 8, Income Taxes, to the consolidated financial statements for additional information.
53rd Week:
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 included a 53rd week of activity.
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Series A Preferred Stock:
On June 7, 2016, we redeemed all outstanding shares of our Series A Preferred Stock. We funded this redemption primarily through the issuance of long-term debt in May 2016, as well as other sources of liquidity, including our commercial paper program, U.S. securitization program, and cash on hand.
See Equity and Dividends within this item, along with Note 16, Debt, and Note 17, Capital Stock, to the consolidated financial statements for additional information.
Results of Operations
Due to the size of Kraft’s business relative to the size of Heinz’s business prior to the 2015 Merger, and for purposes of comparability, the Results of Operations include certain unaudited pro forma condensed combined financial information (the “pro forma financial information”) adjusted to assume that Kraft and Heinz were a combined company for the full year 2015. This pro forma financial information reflects combined historical results, final purchase accounting adjustments, and adjustments to align accounting policies. The pro forma adjustments impacted our consolidated results and all of our segments. There are no pro forma adjustments for 2017 or 2016 as Kraft and Heinz were a combined company for these periods. For more information, see Supplemental Unaudited Pro Forma Condensed Combined Financial Information.
In addition, we disclose in this report certain non-GAAP financial measures, which, for 2015, are derived from the pro forma financial information. 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 Supplemental Unaudited Pro Forma Condensed Combined Financial Information and Non-GAAP Financial Measures.
Consolidated Results of Operations
Summary of Results:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions, except per share data) | (in millions, except per share data) | ||||||||||||||||||||
Net sales | $ | 26,232 | $ | 26,487 | (1.0 | )% | $ | 26,487 | $ | 18,338 | 44.4 | % | |||||||||
Operating income | 6,773 | 6,142 | 10.3 | % | 6,142 | 2,639 | 132.7 | % | |||||||||||||
Net income/(loss) attributable to common shareholders | 10,999 | 3,452 | 218.6 | % | 3,452 | (266 | ) | nm | |||||||||||||
Diluted earnings/(loss) per share | 8.95 | 2.81 | 218.5 | % | 2.81 | (0.34 | ) | nm | |||||||||||||
Net Sales:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Net sales | $ | 26,232 | $ | 26,487 | (1.0 | )% | $ | 26,487 | $ | 18,338 | 44.4 | % | |||||||||
Pro forma net sales(a) | 26,232 | 26,487 | (1.0 | )% | 26,487 | 27,447 | (3.5 | )% | |||||||||||||
Organic Net Sales(b) | 26,169 | 26,432 | (1.0 | )% | 26,817 | 26,728 | 0.3 | % | |||||||||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | 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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Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Net sales and Organic Net Sales decreased 1.0% to $26.2 billion in 2017 compared to 2016 due to unfavorable volume/mix (1.5 pp) partially offset by higher pricing (0.5 pp). Volume/mix was unfavorable in the United States and Canada, partially offset by growth in Europe and Rest of World. Higher pricing in Rest of World and the United States was partially offset by lower pricing in Canada and Europe.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Net sales increased 44.4% to $26.5 billion in 2016 compared to 2015, primarily driven by the 2015 Merger.
Pro forma net sales decreased 3.5% primarily due to the unfavorable impacts of foreign currency (2.5 pp), 53rd week of shipments in 2015 (1.2 pp), and divestitures (0.1 pp). Excluding these impacts, Organic Net Sales increased 0.3% due to higher net pricing (0.3 pp) and neutral volume/mix (0.0 pp). Net pricing was higher in Rest of World, United States, and Canada despite deflation in key commodities (which we define as dairy, meat, coffee and nuts) in the United States and Canada, primarily in dairy, coffee, and meats in the United States. These price increases were partially offset by lower net pricing in Europe. Neutral volume/mix was primarily due to declines in meats and foodservice in the United States, partially offset by growth of condiments and sauces globally, and coffee and refrigerated meal combinations in the United States.
Net Income:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Operating income | $ | 6,773 | $ | 6,142 | 10.3 | % | $ | 6,142 | $ | 2,639 | 132.7 | % | |||||||||
Net income/(loss) attributable to common shareholders | 10,999 | 3,452 | 218.6 | % | 3,452 | (266 | ) | nm | |||||||||||||
Adjusted EBITDA(a) | 7,930 | 7,778 | 1.9 | % | 7,778 | 6,739 | 15.4 | % | |||||||||||||
(a) | Adjusted EBITDA is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Operating income increased 10.3% to $6.8 billion in 2017 compared to $6.1 billion in 2016. This increase was primarily due to lower Integration Program and other restructuring expenses in the current period, savings from the Integration Program and other restructuring activities, and lower overhead costs, partially offset by higher input costs in local currency, lower Organic Net Sales, lower unrealized gains on commodity hedges in the current period, and the unfavorable impact of foreign currency (0.4 pp).
Net income/(loss) attributable to common shareholders increased 218.6% to $11.0 billion in 2017 compared to $3.5 billion in 2016. The increase was primarily due to a lower effective tax rate in the current period, the operating income factors discussed above, and the absence of the Series A Preferred Stock dividend in the current period, partially offset by higher interest expense and higher other expense/(income), net, detailed as follows:
• | The effective tax rate was a 98.7% benefit in 2017 compared to 27.5% expense in 2016. The change in the effective tax rate was primarily driven by the $7.0 billion tax benefit from U.S. Tax Reform, lower tax benefits associated with deferred tax effects of statutory rate changes, and taxes on income of foreign subsidiaries in the current period. See Note 8, Income Taxes, to the consolidated financial statements for additional information related to our effective tax rates. |
• | The Series A Preferred Stock was fully redeemed on June 7, 2016. Accordingly, there were no dividends for 2017, compared to $180 million in the prior period. See Equity and Dividends within this item for additional information. |
• | Interest expense increased to $1.2 billion in 2017 compared to $1.1 billion in 2016. This increase was primarily due to the May 2016 issuances of long-term debt and borrowings under our commercial paper programs, which began in the second quarter of 2016. |
• | Other expense/(income), net was an expense of $9 million in 2017 compared to income of $15 million in 2016. This increase was primarily due to a $36 million nonmonetary currency devaluation loss in the current period compared to $24 million in the prior period related to our Venezuelan operations. See Note 13, Venezuela - Foreign Currency and Inflation, to the consolidated financial statements for additional information. |
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Adjusted EBITDA increased 1.9% to $7.9 billion in 2017 compared to 2016, primarily due to savings from the Integration Program and other restructuring activities and lower overhead costs, partially offset by higher input costs in local currency, a decline in Organic Net Sales, and the unfavorable impact of foreign currency (0.4pp). Segment Adjusted EBITDA results were as follows:
• | United States Segment Adjusted EBITDA increased primarily driven by Integration Program savings and lower overhead costs in the current period, partially offset by unfavorable key commodity costs, primarily in dairy, meat, and coffee, and volume/mix declines. |
• | Europe Segment Adjusted EBITDA was flat primarily driven by productivity savings that were offset by higher input costs in local currency and the unfavorable impact of foreign currency (1.6 pp). |
• | Rest of World Segment Adjusted EBITDA decreased primarily due to higher input costs in local currency, increased commercial investments, and the unfavorable impact of foreign currency (3.4 pp), partially offset by Organic Net Sales growth. |
• | Canada Segment Adjusted EBITDA decreased primarily due to a decline in Organic Net Sales, partially offset by Integration Program savings, lower overhead costs in the current period, and the favorable impact of foreign currency (1.7 pp). |
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Operating income increased 132.7% to $6.1 billion in 2016 compared to $2.6 billion in 2015. This increase was primarily driven by the 2015 Merger, as well as the following:
• | Savings from the Integration Program and other restructuring activities and favorable pricing net of key commodity costs in United States and Canada. |
• | Non-cash costs of $347 million relating to the fair value adjustment of Kraft’s inventory in purchase accounting in the prior period. |
The increase in operating income was partially offset by unfavorable impacts of $188 million from foreign currency and $62 million from a 53rd week of shipments in the prior period.
Net income/(loss) attributable to common shareholders increased $3.7 billion to income of $3.5 billion in 2016 compared to a loss of $266 million in 2015. The increase was due to the growth in operating income, fewer Series A Preferred Stock dividend payments, lower other expense/(income), net, lower interest expense, and a lower effective tax rate, detailed as follows:
• | Series A Preferred Stock dividend cash distributions decreased to $180 million in 2016 compared to $900 million in 2015. This decrease was primarily due to the redemption of the Series A Preferred Stock on June 7, 2016. In addition, due to the December 8, 2015 common stock dividend declaration, we were required to accelerate payment of the March 7, 2016 preferred dividend to December 8, 2015. This resulted in one Series A Preferred Stock dividend payment in the current period compared to five in the prior period. |
• | Other expense/(income), net improved to income of $15 million in 2016, compared to expense of $305 million in 2015. The decrease was primarily due to a $234 million nonmonetary currency devaluation loss related to our Venezuelan subsidiary in the prior period and call premiums of $105 million related to our 2015 debt refinancing activities. |
• | Interest expense decreased to $1.1 billion in 2016 compared to $1.3 billion in 2015. This decrease was primarily due to a $236 million write-off of debt issuance costs related to 2015 debt refinancing activities and a $227 million loss released from accumulated other comprehensive income/(losses) due to the early termination of certain interest rate swaps in the prior period as well as lower interest rates following our debt refinancing in connection with the 2015 Merger. These were partially offset by the assumption of $8.6 billion aggregate principal amount of Kraft’s long-term debt obligations in the 2015 Merger, the issuance of new long-term debt in conjunction with the redemption of our Series A Preferred Stock, and new borrowings under our commercial paper program. See Note 16, Debt, and Note 17, Capital Stock, to the consolidated financial statements for additional information. |
• | The effective tax rate was 27.5% in 2016, compared to 36.2% in 2015. The change in effective tax rate was primarily driven by higher earnings repatriation charges and the nondeductible nonmonetary currency devaluation loss related to our Venezuelan subsidiary in the prior period, partially offset by lower tax benefits associated with taxes on income of foreign subsidiaries, tax exempt income, and deferred tax effects of statutory rate changes in the current period. See Note 8, Income Taxes, to the consolidated financial statements for a discussion of effective tax rates. |
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Adjusted EBITDA increased 15.4% to $7.8 billion in 2016 compared to 2015, primarily driven by savings from the Integration Program and other restructuring activities and favorable pricing net of key commodity costs, partially offset by the unfavorable impact of foreign currency (3.4 pp) and a 53rd week of shipments in the prior period (approximately 1.5 pp). Segment Adjusted EBITDA results were as follows:
• | United States Segment Adjusted EBITDA growth was primarily driven by savings from the Integration Program and favorable pricing net of key commodity costs, partially offset by volume/mix declines and the impact of a 53rd week of shipments (approximately 1.5 pp) in the prior period. |
• | Canada Segment Adjusted EBITDA growth was primarily driven by savings from the Integration Program and favorable pricing net of key commodity costs, partially offset by higher input costs in local currency, unfavorable impact of foreign currency (4.4 pp), and a 53rd week of shipments (approximately 1.5 pp) in the prior period. |
• | Europe Segment Adjusted EBITDA decreased primarily due to unfavorable impact of foreign currency (6.5 pp), lower pricing, impact of a 53rd week of shipments (approximately 1.0 pp) in the prior period as well as an increase in marketing investments, partially offset by savings in manufacturing costs. |
• | Rest of World Segment Adjusted EBITDA decreased due to unfavorable impact of foreign currency (17.4 pp), increased marketing investments, and a 53rd week of shipments (approximately 1.0 pp) in the prior period, partially offset by organic sales growth. |
Diluted EPS:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions, except per share data) | (in millions, except per share data) | ||||||||||||||||||||
Diluted EPS | $ | 8.95 | $ | 2.81 | 218.5 | % | $ | 2.81 | $ | (0.34 | ) | nm | |||||||||
Adjusted EPS(a) | 3.55 | 3.33 | 6.6 | % | 3.33 | 2.19 | 52.1 | % | |||||||||||||
(a) | Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Diluted EPS increased 218.5% to $8.95 in 2017 compared to $2.81 in 2016, primarily driven by the net income/(loss) attributable to common shareholders factors discussed above.
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | $ Change | % Change | |||||||||||
Diluted EPS | $ | 8.95 | $ | 2.81 | $ | 6.14 | 218.5 | % | ||||||
Integration and restructuring expenses | 0.26 | 0.57 | (0.31 | ) | ||||||||||
Merger costs | — | 0.02 | (0.02 | ) | ||||||||||
Unrealized losses/(gains) on commodity hedges | 0.01 | (0.02 | ) | 0.03 | ||||||||||
Impairment losses | 0.03 | 0.03 | — | |||||||||||
Nonmonetary currency devaluation | 0.03 | 0.02 | 0.01 | |||||||||||
Preferred dividend adjustment | — | (0.10 | ) | 0.10 | ||||||||||
U.S. Tax Reform | (5.73 | ) | — | (5.73 | ) | |||||||||
Adjusted EPS(a) | $ | 3.55 | $ | 3.33 | $ | 0.22 | 6.6 | % | ||||||
Key drivers of change in Adjusted EPS(a): | ||||||||||||||
Results of operations | $ | 0.06 | ||||||||||||
Change in preferred dividends | 0.25 | |||||||||||||
Change in interest expense | (0.06 | ) | ||||||||||||
Change in other expense/(income), net | (0.01 | ) | ||||||||||||
Change in effective tax rate and other | (0.02 | ) | ||||||||||||
$ | 0.22 | |||||||||||||
(a) | Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
24
Adjusted EPS increased 6.6% to $3.55 in 2017 compared to $3.33 in 2016, primarily driven by the absence of Series A Preferred Stock dividends in the current period and Adjusted EBITDA growth despite the unfavorable impact of foreign currency, partially offset by higher interest expense.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Diluted EPS increased to earnings of $2.81 in 2016 compared to a loss of $0.34 in 2015. The increase in diluted earnings/(loss) per share was driven primarily by the net income/(loss) attributable to common shareholders factors discussed above, partially offset by the effect of an increase in the weighted average shares of common stock outstanding compared to the prior period and a 53rd week of shipments in the prior period.
December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | $ Change | % Change | |||||||||||
Diluted EPS | $ | 2.81 | $ | (0.34 | ) | $ | 3.15 | nm | ||||||
Pro forma adjustments(a) | — | 1.04 | (1.04 | ) | ||||||||||
Pro forma diluted EPS | 2.81 | 0.70 | 2.11 | 301.4 | % | |||||||||
Integration and restructuring expenses | 0.57 | 0.61 | (0.04 | ) | ||||||||||
Merger costs | 0.02 | 0.49 | (0.47 | ) | ||||||||||
Unrealized losses/(gains) on commodity hedges | (0.02 | ) | (0.02 | ) | — | |||||||||
Impairment losses | 0.03 | 0.03 | — | |||||||||||
Losses/(gains) on sale of business | — | (0.01 | ) | 0.01 | ||||||||||
Nonmonetary currency devaluation | 0.02 | 0.24 | (0.22 | ) | ||||||||||
Preferred dividend adjustment | (0.10 | ) | 0.15 | (0.25 | ) | |||||||||
Adjusted EPS(c) | $ | 3.33 | $ | 2.19 | $ | 1.14 | 52.1 | % | ||||||
Key drivers of change in Adjusted EPS(b): | ||||||||||||||
Results of operations | $ | 0.77 | ||||||||||||
Change in preferred dividends | 0.34 | |||||||||||||
Change in interest expense | (0.04 | ) | ||||||||||||
Change in other expense/(income), net | (0.03 | ) | ||||||||||||
53rd week of shipments | (0.03 | ) | ||||||||||||
Change in effective tax rate and other | 0.13 | |||||||||||||
$ | 1.14 | |||||||||||||
(a) | There were no pro forma adjustments for 2016, as Kraft and Heinz were a combined company for the entire period. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Adjusted EPS increased 52.1% to $3.33 in 2016 compared to $2.19 in 2015, primarily driven by Adjusted EBITDA growth despite the unfavorable impact of foreign currency, fewer Series A Preferred Stock dividends and a lower effective tax rate, partially offset by higher interest expense, higher other expense/(income), net, and a 53rd week of shipments in the prior period.
Results of Operations by Segment
Management evaluates segment performance based on several factors, including net sales, Organic Net Sales, and segment adjusted earnings before interest, tax, depreciation, and amortization (“Segment Adjusted EBITDA”). Management uses Segment Adjusted EBITDA to evaluate segment performance and allocate resources. Segment Adjusted EBITDA 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. These items include depreciation and amortization (excluding integration and restructuring expenses; including amortization of postretirement benefit plans prior service credits), equity award compensation expense, integration and restructuring expenses, merger 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, gains/(losses) on the sale of a business, and nonmonetary currency devaluation (e.g., remeasurement gains and losses). In addition, consistent with the manner in which management evaluates segment performance and allocates resources, Segment Adjusted EBITDA includes the operating results of Kraft on a pro forma basis, as if Kraft had been acquired as of December 30, 2013.
25
Net Sales:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | |||||||||
(in millions) | |||||||||||
Net sales: | |||||||||||
United States | $ | 18,353 | $ | 18,641 | $ | 10,943 | |||||
Canada | 2,190 | 2,309 | 1,437 | ||||||||
Europe | 2,393 | 2,366 | 2,656 | ||||||||
Rest of World | 3,296 | 3,171 | 3,302 | ||||||||
Total net sales | $ | 26,232 | $ | 26,487 | $ | 18,338 | |||||
Pro Forma Net Sales:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | |||||||||
(in millions) | |||||||||||
Pro forma net sales(a): | |||||||||||
United States | $ | 18,353 | $ | 18,641 | $ | 18,932 | |||||
Canada | 2,190 | 2,309 | 2,386 | ||||||||
Europe | 2,393 | 2,366 | 2,657 | ||||||||
Rest of World | 3,296 | 3,171 | 3,472 | ||||||||
Total pro forma net sales | $ | 26,232 | $ | 26,487 | $ | 27,447 | |||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
Organic Net Sales:
2017 Compared to 2016 | 2016 Compared to 2015 | ||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | ||||||||||||
(in millions) | |||||||||||||||
Organic Net Sales(a): | |||||||||||||||
United States | $ | 18,353 | $ | 18,641 | $ | 18,641 | $ | 18,699 | |||||||
Canada | 2,148 | 2,309 | 2,393 | 2,359 | |||||||||||
Europe | 2,385 | 2,366 | 2,520 | 2,588 | |||||||||||
Rest of World | 3,283 | 3,116 | 3,263 | 3,082 | |||||||||||
Total Organic Net Sales | $ | 26,169 | $ | 26,432 | $ | 26,817 | $ | 26,728 | |||||||
(a) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
26
Drivers of the changes in pro forma net sales and Organic Net Sales were:
Pro Forma Net Sales(a) | Impact of Currency | Impact of Divestitures | Impact of 53rd Week | Organic Net Sales | Price | Volume/Mix | |||||||||
2017 Compared to 2016 | |||||||||||||||
United States | (1.5 | )% | 0.0 pp | 0.0 pp | 0.0 pp | (1.5 | )% | 0.4 pp | (1.9) pp | ||||||
Canada | (5.2 | )% | 1.8 pp | 0.0 pp | 0.0 pp | (7.0 | )% | (1.7) pp | (5.3) pp | ||||||
Europe | 1.1 | % | 0.3 pp | 0.0 pp | 0.0 pp | 0.8 | % | (0.9) pp | 1.7 pp | ||||||
Rest of World | 3.9 | % | (1.5) pp | 0.0 pp | 0.0 pp | 5.4 | % | 4.6 pp | 0.8 pp | ||||||
Kraft Heinz | (1.0 | )% | 0.0 pp | 0.0 pp | 0.0 pp | (1.0 | )% | 0.5 pp | (1.5) pp | ||||||
2016 Compared to 2015 | |||||||||||||||
United States | (1.5 | )% | 0.0 pp | 0.0 pp | (1.2) pp | (0.3 | )% | 0.2 pp | (0.5) pp | ||||||
Canada | (3.2 | )% | (3.5) pp | 0.0 pp | (1.1) pp | 1.4 | % | 0.6 pp | 0.8 pp | ||||||
Europe | (11.0 | )% | (5.8) pp | (1.6) pp | (1.0) pp | (2.6 | )% | (2.5) pp | (0.1) pp | ||||||
Rest of World | (8.7 | )% | (13.2) pp | 0.0 pp | (1.4) pp | 5.9 | % | 3.2 pp | 2.7 pp | ||||||
Kraft Heinz | (3.5 | )% | (2.5) pp | (0.1) pp | (1.2) pp | 0.3 | % | 0.3 pp | 0.0 pp | ||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
Adjusted EBITDA:
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | |||||||||
(in millions) | |||||||||||
Segment Adjusted EBITDA: | |||||||||||
United States | $ | 6,001 | $ | 5,862 | $ | 4,690 | |||||
Canada | 639 | 642 | 541 | ||||||||
Europe | 781 | 781 | 938 | ||||||||
Rest of World | 617 | 657 | 742 | ||||||||
General corporate expenses | (108 | ) | (164 | ) | (172 | ) | |||||
Depreciation and amortization (excluding integration and restructuring expenses) | (583 | ) | (536 | ) | (779 | ) | |||||
Integration and restructuring expenses | (457 | ) | (1,012 | ) | (1,117 | ) | |||||
Merger costs | — | (30 | ) | (194 | ) | ||||||
Amortization of inventory step-up | — | — | (347 | ) | |||||||
Unrealized gains/(losses) on commodity hedges | (19 | ) | 38 | 41 | |||||||
Impairment losses | (49 | ) | (53 | ) | (58 | ) | |||||
Gains/(losses) on sale of business | — | — | 21 | ||||||||
Nonmonetary currency devaluation | — | (4 | ) | (57 | ) | ||||||
Equity award compensation expense (excluding integration and restructuring expenses) | (49 | ) | (39 | ) | (61 | ) | |||||
Other pro forma adjustments | — | — | (1,549 | ) | |||||||
Operating income | 6,773 | 6,142 | 2,639 | ||||||||
Interest expense | 1,234 | 1,134 | 1,321 | ||||||||
Other expense/(income), net | 9 | (15 | ) | 305 | |||||||
Income/(loss) before income taxes | $ | 5,530 | $ | 5,023 | $ | 1,013 | |||||
27
United States:
2017 Compared to 2016 | 2016 Compared to 2015 | ||||||||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Net sales | $ | 18,353 | $ | 18,641 | (1.5 | )% | $ | 18,641 | $ | 10,943 | 70.3 | % | |||||||||
Pro forma net sales(a) | 18,353 | 18,641 | (1.5 | )% | 18,641 | 18,932 | (1.5 | )% | |||||||||||||
Organic Net Sales(b) | 18,353 | 18,641 | (1.5 | )% | 18,641 | 18,699 | (0.3 | )% | |||||||||||||
Segment Adjusted EBITDA | 6,001 | 5,862 | 2.4 | % | 5,862 | 4,690 | 25.0 | % | |||||||||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Net sales and Organic Net Sales decreased 1.5% to $18.4 billion due to unfavorable volume/mix (1.9 pp) partially offset by higher pricing (0.4 pp). Unfavorable volume/mix was primarily driven by distribution losses in nuts, cheese, and meat, and lower shipments in foodservice. The decline was partially offset by gains in refrigerated meal combinations, boxed dinners, and frozen meals. Pricing was higher driven primarily by price increases in cheese.
Segment Adjusted EBITDA increased 2.4% primarily driven by Integration Program savings and lower overhead costs, partially offset by unfavorable key commodity costs, primarily in dairy, meat, and coffee, as well as unfavorable volume/mix.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Net sales increased 70.3% to $18.6 billion primarily driven by the 2015 Merger. Pro forma net sales decreased 1.5% due to a 53rd week of shipments in the prior period (1.2 pp). Organic Net Sales decreased 0.3% due to unfavorable volume/mix (0.5 pp) partially offset by higher net pricing (0.2 pp). Unfavorable volume/mix was primarily due to declines in meat, foodservice, ready-to-drink beverages, and nuts that were partially offset by gains in coffee and innovation-related gains in refrigerated meal combinations and boxed dinners. Net pricing was higher despite deflation in key commodities, primarily in dairy, coffee, and meat.
Segment Adjusted EBITDA increased 25.0% primarily due to savings from the Integration Program and favorable pricing net of key commodity costs, partially offset by volume/mix declines across several categories and the impact of a 53rd week of shipments (approximately 1.5 pp) in the prior period.
Canada:
2017 Compared to 2016 | 2016 Compared to 2015 | ||||||||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Net sales | $ | 2,190 | $ | 2,309 | (5.2 | )% | $ | 2,309 | $ | 1,437 | 60.7 | % | |||||||||
Pro forma net sales(a) | 2,190 | 2,309 | (5.2 | )% | 2,309 | 2,386 | (3.2 | )% | |||||||||||||
Organic Net Sales(b) | 2,148 | 2,309 | (7.0 | )% | 2,393 | 2,359 | 1.4 | % | |||||||||||||
Segment Adjusted EBITDA | 639 | 642 | (0.5 | )% | 642 | 541 | 18.7 | % | |||||||||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Net sales decreased 5.2% to $2.2 billion, including the favorable impact of foreign currency (1.8 pp). Organic Net Sales decreased 7.0% due to unfavorable volume/mix (5.3 pp) and lower pricing (1.7 pp). Volume/mix was unfavorable across several categories and was most pronounced in cheese, coffee, and boxed dinners, primarily due to delayed execution of go-to-market agreements with key retailers, retail distribution losses (primarily in cheese), and lower inventory levels at retail versus the prior year. Lower pricing was due to higher promotional activity, primarily in cheese.
28
Segment Adjusted EBITDA decreased 0.5%, including favorable impact of foreign currency (1.7 pp). Excluding the currency impact, Segment Adjusted EBITDA decreased primarily due to lower Organic Net Sales partially offset by Integration Program savings and lower overhead costs in the current period.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Net sales increased 60.7% to $2.3 billion primarily driven by the 2015 Merger. Pro forma net sales decreased 3.2% due to the unfavorable impact of foreign currency (3.5 pp) and a 53rd week of shipments in the prior period (1.1 pp). Organic Net Sales increased 1.4% driven by favorable volume/mix (0.8 pp) and higher net pricing (0.6 pp). Favorable volume/mix reflected higher shipments of condiments and sauces and gains in foodservice that were partially offset by lower shipments in cheese versus the prior year. Price increases were driven by significant pricing actions taken to offset higher input costs in local currency.
Segment Adjusted EBITDA increased 18.7% despite the unfavorable impact of foreign currency (4.4 pp). This increase was primarily driven by Integration Program savings and favorable pricing net of key commodity costs, partially offset by higher input costs in local currency and the impact of a 53rd week of shipments (approximately 1.5 pp) in the prior period.
Europe:
2017 Compared to 2016 | 2016 Compared to 2015 | ||||||||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Net sales | $ | 2,393 | $ | 2,366 | 1.1 | % | $ | 2,366 | $ | 2,656 | (10.9 | )% | |||||||||
Pro forma net sales(a) | 2,393 | 2,366 | 1.1 | % | 2,366 | 2,657 | (11.0 | )% | |||||||||||||
Organic Net Sales(b) | 2,385 | 2,366 | 0.8 | % | 2,520 | 2,588 | (2.6 | )% | |||||||||||||
Segment Adjusted EBITDA | 781 | 781 | — | % | 781 | 938 | (16.7 | )% | |||||||||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Net sales increased 1.1% to $2.4 billion, including favorable impact of foreign currency (0.3 pp). Organic Net Sales increased 0.8% driven by favorable volume/mix (1.7 pp), partially offset by lower pricing (0.9 pp). Favorable volume/mix was primarily driven by higher shipments in foodservice and growth in condiments and sauces, partially offset by ongoing declines in infant nutrition in Italy. Lower pricing was primarily due to higher promotional activity in the UK and Italy versus the prior period.
Segment Adjusted EBITDA was flat, including the unfavorable impact of foreign currency (1.6 pp). Excluding the currency impact, the increase was primarily driven by productivity savings, partially offset by higher input costs in local currency.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Net sales decreased 10.9% to $2.4 billion, reflecting the unfavorable impacts of foreign currency, divestitures, and a 53rd week of shipments in the prior period. Pro forma net sales decreased 11.0% partially due to the unfavorable impacts of foreign currency (5.8 pp), divestitures (1.6 pp), and a 53rd week of shipments in the prior period (1.0 pp). Organic Net Sales decreased 2.6% due to lower net pricing (2.5 pp) and unfavorable volume/mix (0.1 pp). Lower net pricing was primarily due to increased promotional activity across most categories versus the prior period. Unfavorable volume/mix was primarily due to lower shipments across most categories in the UK partially offset by growth in condiments and sauces.
Segment Adjusted EBITDA decreased 16.7% partially due to the unfavorable impact of foreign currency (6.5 pp). Excluding the currency impact, the Segment Adjusted EBITDA decline was primarily due to lower net pricing, the impact of a 53rd week of shipments (approximately 1.0 pp) in the prior period as well as an increase in marketing investments, partially offset by savings in manufacturing costs.
29
Rest of World:
2017 Compared to 2016 | 2016 Compared to 2015 | ||||||||||||||||||||
December 30, 2017 (52 weeks) | December 31, 2016 (52 weeks) | % Change | December 31, 2016 (52 weeks) | January 3, 2016 (53 weeks) | % Change | ||||||||||||||||
(in millions) | (in millions) | ||||||||||||||||||||
Net sales | $ | 3,296 | $ | 3,171 | 3.9 | % | $ | 3,171 | $ | 3,302 | (4.0 | )% | |||||||||
Pro forma net sales(a) | 3,296 | 3,171 | 3.9 | % | 3,171 | 3,472 | (8.7 | )% | |||||||||||||
Organic Net Sales(b) | 3,283 | 3,116 | 5.4 | % | 3,263 | 3,082 | 5.9 | % | |||||||||||||
Segment Adjusted EBITDA | 617 | 657 | (6.1 | )% | 657 | 742 | (11.5 | )% | |||||||||||||
(a) | There were no pro forma adjustments for 2017 or 2016, as Kraft and Heinz were a combined company for these periods. See the Supplemental Unaudited Pro Forma Condensed Combined Financial Information at the end of this item. |
(b) | Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item. |
Year Ended December 30, 2017 compared to the Year Ended December 31, 2016:
Net sales increased 3.9% to $3.3 billion despite the unfavorable impact of foreign currency (1.5 pp). Organic Net Sales increased 5.4% driven by higher pricing (4.6 pp) and favorable volume/mix (0.8 pp). Higher pricing was primarily driven by pricing actions taken to offset higher input costs in local currency, primarily in Latin America. Favorable volume/mix was primarily driven by growth in condiments and sauces across all regions partially offset by volume/mix declines in several markets associated with distributor network re-alignment.
Segment Adjusted EBITDA decreased 6.1% including the unfavorable impact of foreign currency (3.4 pp). Excluding the currency impact, Segment Adjusted EBITDA decreased primarily due to higher input costs in local currency and higher commercial investments partially offset by Organic Net Sales growth.
Year Ended December 31, 2016 compared to the Year Ended January 3, 2016:
Net sales decreased 4.0% to $3.2 billion, reflecting the unfavorable impacts of foreign currency and a 53rd week of shipments in the prior period, which were partially offset by the inclusion of twelve months of the Kraft business in the current period. Pro forma net sales decreased 8.7% due to the unfavorable impacts of foreign currency (13.2 pp, including a 10.5 pp impact from the devaluation of the Venezuelan bolivar) and a 53rd week of shipments in the prior period (1.4 pp). Organic Net Sales increased 5.9% driven by higher net pricing (3.2 pp) and favorable volume/mix (2.7 pp). Higher net pricing was driven primarily by pricing actions to offset higher input costs in local currency, primarily in Latin America. Favorable volume/mix was primarily driven by growth in condiments and sauces across all regions, partially offset by declines in nutritional beverages in India.
Segment Adjusted EBITDA decreased 11.5% primarily due to the unfavorable impact of foreign currency (17.4 pp, including a 14.0 pp impact from the devaluation of the Venezuelan bolivar). Excluding the currency impact, Segment Adjusted EBITDA increased, primarily driven by organic sales growth that was partially offset by increased marketing investments and a 53rd week of shipments (approximately 1.0 pp) in the prior period.
Critical Accounting Policies
Note 1, Background and Basis of Presentation, to the consolidated financial statements 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 the accounting policies we used to prepare our consolidated financial statements.
Principles of Consolidation:
The consolidated financial statements include The Kraft Heinz Company, as well as our wholly-owned and majority-owned subsidiaries. All intercompany transactions are eliminated.
Revenue Recognition:
We recognize revenues when title and risk of loss pass to our customers. We record revenues net of consumer incentives and trade promotions and include all shipping and handling charges billed to customers. We also record provisions 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.
30
Advertising, Consumer Incentives, and Trade Promotions:
We promote our products with advertising, consumer incentives, and 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. Consumer incentive and trade promotion activities are 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, or current period experience factors. We review and adjust these estimates each quarter 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 review and adjust these estimates each quarter based on actual experience and other information. We recorded advertising expenses of $629 million in 2017, $708 million in 2016, and $464 million in 2015.
Goodwill and Intangible Assets:
The carrying value of goodwill and indefinite-lived intangible assets was $98.5 billion at December 30, 2017 and $97.4 billion at December 31, 2016. These balances are largely attributable to asset valuations performed in connection with the 2013 Merger and the 2015 Merger. See Note 2, Merger and Acquisition, and Note 7, Goodwill and Intangible Assets, for additional information.
We test goodwill and indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. The first step of the goodwill impairment test compares the reporting unit’s estimated fair value with its carrying value. If the carrying value of a reporting unit’s net assets exceeds its fair value, the second step would be applied to measure the difference between the carrying value and implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, the goodwill would be considered impaired and would be reduced to its implied fair value. We test indefinite-lived intangible assets for impairment by comparing the fair value of each intangible asset with its carrying value. If the carrying value exceeds fair value, the intangible asset would be considered impaired and would be reduced to fair value.
We performed our annual impairment testing in the second quarter of 2017. No impairment of goodwill was reported as a result of our 2017 annual goodwill impairment test. Each of our goodwill reporting units had excess fair value over its carrying value of at least 10% as of April 2, 2017 (our goodwill impairment testing date). Additionally, as a result of our annual indefinite-lived intangible asset impairment tests, we recognized a non-cash impairment loss of $49 million in SG&A in 2017. This loss was due to continued declines in nutritional beverages in India. The loss was recorded in our Europe segment as the related trademark is owned by our Italian subsidiary. Each of our other brands had excess fair value over its carrying value of at least 10% as of April 2, 2017.
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 indefinite-lived intangible assets requires us to make assumptions and estimates regarding our future plans, as well as industry and economic conditions. These assumptions and estimates include projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors. If current expectations of future growth rates are not met or market factors outside of our control, such as discount rates, change significantly, then one or more of our reporting units or intangible assets might become impaired in the future. Additionally, as goodwill and intangible assets associated with recently acquired businesses are recorded on the balance sheet at their estimated acquisition date fair values, those amounts are more susceptible to an impairment risk if business operating results or macroeconomic conditions deteriorate.
Definite-lived intangible assets are amortized on a straight-line basis over the estimated periods benefited, and are reviewed when appropriate for possible impairment.
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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 the working life of the covered employees. We generally amortize net actuarial gains or losses in future periods within cost of products sold and SG&A.
For our postretirement benefit plans, our 2018 health care cost trend rate assumption will be 6.7%. 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 2018 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 30, 2017 (in millions):
One-Percentage-Point | |||||||
Increase | (Decrease) | ||||||
Effect on annual service and interest cost | $ | 4 | $ | (3 | ) | ||
Effect on postretirement benefit obligation | 55 | (47 | ) | ||||
Our 2018 discount rate assumption will be 3.6% for service cost and 3.0% for interest cost for our postretirement plans. Our 2018 discount rate assumption will be 3.8% for service cost and 3.3% for interest cost for our U.S. pension plans and 3.0% for service cost and 2.2% 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.
In 2016, we changed the method we use to estimate the service cost and interest cost components of net pension cost/(benefit) and net postretirement benefit plan costs resulting in a decrease to these cost components. We now use a full yield curve approach to estimate service cost and interest cost by applying the specific spot rates along the yield curve used to determine the benefit obligation to the relevant projected cash flows. Previously, we estimated service cost and interest cost using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. We made this change to provide a more precise measurement of service cost and interest cost by improving the correlation between projected benefit cash flows and the corresponding spot yield curve rates. This change will not affect the measurement of our total benefit obligations. We accounted for this change prospectively as a change in accounting estimate.
Our 2018 expected return on plan assets will be 4.4% (net of applicable taxes) for our postretirement plans. Our 2018 expected rate of return on plan assets will be 5.5% for our U.S. pension plans and 4.5% 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 2018 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 had 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 | $ | 9 | $ | (19 | ) | $ | 8 | $ | (21 | ) | |||||
Effect of change in expected rate of return on plan assets on pension costs | (46 | ) | 46 | (41 | ) | 41 | |||||||||
Effect of change in discount rate on postretirement costs | (4 | ) | (9 | ) | — | (1 | ) | ||||||||
Effect of change in expected rate of return on plan assets on postretirement costs | (11 | ) | 11 | — | — | ||||||||||
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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 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 charge 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.
U.S. Tax Reform significantly changed U.S. tax law by, among other things, lowering the federal corporate tax rate from 35.0% to 21.0%, effective January 1, 2018, implementing a territorial tax system, and imposing a one-time toll charge on deemed repatriated earnings of foreign subsidiaries as of December 30, 2017. In addition, there are many new provisions, including changes to bonus depreciation, the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income provisions (“GILTI”), the base erosion anti-abuse tax (“BEAT”), and a deduction for foreign-derived intangible income (“FDII”). The two material items that impacted us in 2017 were the corporate tax rate reduction and the one-time toll charge. While the corporate tax rate reduction is effective January 1, 2018, we accounted for this anticipated rate change in 2017, the period of enactment.
The SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides us with up to one year to finalize accounting for the impacts of U.S. Tax Reform. When the initial accounting for U.S Tax Reform impacts is incomplete, we may include provisional amounts when reasonable estimates can be made or continue to apply the prior tax law if a reasonable estimate cannot be made. We have estimated the provisional tax impacts related to the toll charge, certain components of the revaluation of deferred tax assets and liabilities, including depreciation and executive compensation, and the change in our indefinite reinvestment assertion. As a result, we recognized a net tax benefit of approximately $7.0 billion, including a reasonable estimate of our deferred income tax benefit of approximately $7.5 billion related to the corporate rate change, which was partially offset by a reasonable estimate of $312 million for the toll charge and approximately $125 million for other tax expenses, including a change in our indefinite reinvestment assertion. We have elected to account for the tax on GILTI as a period cost and thus have not adjusted any of the deferred tax assets and liabilities of our foreign subsidiaries for U.S. Tax Reform. The ultimate impact may differ from these provisional amounts due to gathering additional information to more precisely compute the amount of tax, changes in interpretations and assumptions, additional regulatory guidance that may be issued, and actions we may take. We expect to finalize accounting for the impacts of U.S. Tax Reform when the 2017 U.S. corporate income tax return is filed in 2018.
In connection with U.S. Tax Reform, we have also reassessed our international investment assertions and no longer consider the historic earnings of our foreign subsidiaries as of December 30, 2017 to be indefinitely reinvested. We have made a reasonable estimate of local country withholding taxes that would be owed when our historic earnings are distributed. As a result, we have recorded deferred income taxes of $96 million on approximately $1.2 billion of historic earnings.
New Accounting Pronouncements
See Note 1, Background and Basis of Presentation, to the consolidated financial statements for a discussion of new accounting pronouncements.
Contingencies
See Note 15, Commitments and Contingencies, to the consolidated financial statements for a discussion of our contingencies.
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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 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 2017, we experienced cost increases in our key commodities, including dairy, meat, and coffee, while costs for nuts were flat. 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 in our meat business 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.
Liquidity and Capital Resources
We believe that cash generated from our operating activities, securitization programs, commercial paper programs, and Senior Credit Facility (as defined below) will provide sufficient liquidity to meet our working capital needs, restructuring expenditures, planned capital expenditures, contributions to our postemployment benefit plans, future contractual obligations (including repayments of long-term debt), and payment of our anticipated quarterly common stock dividends. We intend to use our cash on hand and our commercial paper programs for daily funding requirements. Overall, we do not expect 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 2017 compared to 2016:
Net Cash Provided by/Used for Operating Activities:
Net cash provided by operating activities was $527 million for the year ended December 30, 2017 compared to $2.6 billion for the year ended December 31, 2016. The decrease in cash provided by operating activities was primarily driven by the $1.2 billion pre-funding of our postretirement benefit plans in 2017, lower collections on receivables as more were non-cash exchanged for sold receivables, favorable changes in accounts payable from vendor payment term renegotiations that were less pronounced than the prior year, and increased cash payments of employee bonuses in 2017. The decrease in cash provided by operating activities was partially offset by lower cash payments for income taxes in 2017 driven by our pre-funding of postretirement plan benefits following U.S. Tax Reform enactment on December 22, 2017.
Net Cash Provided by/Used for Investing Activities:
Net cash provided by investing activities was $1.2 billion for the year ended December 30, 2017 compared to $1.5 billion for the year ended December 31, 2016. The decrease in cash provided by investing activities was primarily due to lower cash inflows from our accounts receivable securitization and factoring programs, as well as lower proceeds from cash settlements on net investment hedges. Capital expenditures were flat in 2017 compared to 2016. We expect 2018 capital expenditures to be approximately $850 million. The expected decrease is primarily attributed to the wind-up of footprint costs in the U.S. and Canada related to our Integration Program.
Net Cash Provided by/Used for Financing Activities:
Net cash used for financing activities was $4.2 billion for the year ended December 30, 2017 compared to $4.6 billion for the year ended December 31, 2016. The decrease was driven by the benefit of fewer dividend payments in 2017 compared to 2016, which more than offset higher net repayments of long-term debt and commercial paper in 2017 compared to 2016, including cash outflows associated with the redemption of our Series A Preferred Stock in 2016. Dividend payments were lower in 2017 compared to 2016 due to the absence of the Series A Preferred Stock dividend and the impact of four common stock cash distributions in 2017 compared to five such distributions in 2016. See Equity and Dividends for additional information on cash distributions related to common stock and Series A Preferred Stock.
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Cash Flow Activity for 2016 compared to 2015:
Net Cash Provided by/Used for Operating Activities:
Net cash provided by operating activities was $2.6 billion in 2016 compared to $1.3 billion in 2015. The increase in cash provided by operating activities was primarily due to an increase in operating income as a result of the 2015 Merger, as well as favorable changes in accounts payable due to payment term extensions from vendor renegotiations. The increase in cash provided by operating activities was partially offset by lower collections on receivables as more were non-cash exchanged for sold receivables, as well as unfavorable changes in other current liabilities, and to a lesser degree, inventories. The change in other current liabilities was primarily driven by increased payments in 2016 related to income taxes.
Net Cash Provided by/Used for Investing Activities:
Net cash provided by investing activities was $1.5 billion in 2016 compared to net cash used for investing activities of $8.3 billion in 2015. The change was primarily driven by increased cash inflows from our accounts receivable securitization and factoring programs, partially offset by an increase in capital expenditures and lower proceeds from cash settlements on net investment hedges. Capital expenditures increased to $1.2 billion in 2016 primarily due to integration and restructuring activities in the United States. The change also reflected cash paid to acquire Kraft in 2015. See Note 2, Merger and Acquisition, to the consolidated financial statements for additional information on the 2015 Merger.
Net Cash Provided by/Used for Financing Activities:
Net cash used for financing activities was $4.6 billion in 2016 compared to net cash provided by financing activities of $10.0 billion in 2015. This decrease in cash provided by financing activities was primarily driven by proceeds of $10.0 billion from our issuance of common stock to the Sponsors in connection with the 2015 Merger, the Series A Preferred Stock redemption in June 2016, and the impact of five common stock cash distributions in 2016 compared to two such cash distributions in 2015. The decrease in cash provided by financing activities was partially offset by net proceeds from our long-term debt issuances in May 2016 and net proceeds from our issuance of commercial paper, which were our primary sources of funding for the Series A Preferred Stock redemption. Additionally, in the prior year we had a benefit from proceeds from the issuance of long-term debt, which were largely offset by repayments of long-term debt. Our cash used for financing activities in 2016 also reflected the impact of one cash distribution related to our Series A Preferred Stock in 2016 compared to five such cash distributions in 2015. See Equity and Dividends within this item for additional information on cash distributions related to common stock and Series A Preferred Stock.
Cash Held by International Subsidiaries:
Of the $1.6 billion cash and cash equivalents on our consolidated balance sheet at December 30, 2017, $1.1 billion was held by international subsidiaries.
In the future, we could repatriate up to approximately $6.5 billion of international cash to the U.S. without incurring any additional significant income tax expense. Our approximately $5.0 billion of unremitted historic earnings of our foreign subsidiaries was taxed via the U.S. Tax Reform toll charge in 2017. In connection with U.S. Tax Reform, we have also reassessed our international investment assertions and no longer consider these earnings to be indefinitely reinvested. We have made a reasonable estimate of local country withholding taxes that would be owed when our historic earnings are distributed. As a result, we have recorded an estimate of $96 million related to deferred income taxes to reflect local country withholding taxes that will be owed when this cash is distributed. The remaining amount of up to approximately $1.5 billion represents intercompany loans and previously taxed income which could be repatriated to the U.S. without incurring any additional significant income tax expense.
Total Debt:
In 2017, we obtained funding through our U.S. and European commercial paper programs. As of December 30, 2017, we had $448 million of commercial paper outstanding, with a weighted average interest rate of 1.541%. As of December 31, 2016, we had $642 million of commercial paper outstanding, with a weighted average interest rate of 1.074%. The maximum amount of commercial paper outstanding during the year ended December 30, 2017 was $1.2 billion.
We maintain our $4.0 billion senior unsecured revolving credit facility (the “Senior Credit Facility”). 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. Our Senior Credit Facility contains customary representations, covenants, and events of default. No amounts were drawn on our Senior Credit Facility at December 30, 2017, at December 31, 2016, or during the years ended December 30, 2017, December 31, 2016, and January 3, 2016.
In August 2017, we repaid $600 million aggregate principal amount of our previously outstanding senior unsecured loan facility (the “Term Loan Facility”). Accordingly, there were no amounts outstanding on the Term Loan Facility at December 30, 2017. At December 31, 2016, $600 million aggregate principal amount of our Term Loan Facility was outstanding.
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Our long-term debt, including the current portion, was $31.1 billion at December 30, 2017 and $31.8 billion at December 31, 2016. The decrease in long-term debt was primarily due to our June 2017 repayment of approximately $2.0 billion aggregate principal amount of senior notes that matured in the period and our August 2017 repayment of the $600 million aggregate principal amount Term Loan Facility. The decrease was partially offset by approximately $1.5 billion aggregate principal amount of long-term debt issued in August 2017. Our long-term debt contains customary representations, covenants, and events of default. We were in compliance with all such covenants at December 30, 2017. See Note 16, Debt, to the consolidated financial statements for additional information.
We have approximately $2.5 billion aggregate principal amount and $C200 million aggregate principal amount of senior notes that will mature in the third quarter of 2018. We expect to fund these long-term debt repayments primarily with new long-term debt issuances, cash on hand, and cash generated from our operating activities.
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.
See Note 14, Financing Arrangements, to the consolidated financial statements for a discussion of our accounts receivable securitization and factoring programs and other financing arrangements.
Aggregate Contractual Obligations:
The following table summarizes our contractual obligations at December 30, 2017 (in millions):
Payments Due | ||||||||||||||
2018 | 2019-2020 | 2021-2022 | 2023 and Thereafter | Total | ||||||||||
Long-term debt(a) | 3,939 | 5,653 | 6,200 | 32,779 | 48,571 | |||||||||
Capital leases(b) | 35 | 34 | 64 | 1 | 134 | |||||||||
Operating leases(c) | 103 | 164 | 99 | 165 | 531 | |||||||||
Purchase obligations(d) | 1,558 | 1,251 | 446 | 439 | 3,694 | |||||||||
Other long-term liabilities(e) | 80 | 106 | 94 | 280 | 560 | |||||||||
Total | 5,715 | 7,208 | 6,903 | 33,664 | 53,490 | |||||||||
(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 30, 2017. |
(b) | Amounts represent the expected cash payments of our capital leases, including expected cash payments of interest expense. |
(c) | Operating leases represent the minimum rental commitments under non-cancelable operating leases. |
(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. A few 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. Future payments related to other long-term liabilities decreased primarily due to payments of $1.2 billion in 2017 to pre-fund a portion of our U.S. postretirement plan benefits. See Note 10, Postemployment Benefits, to the consolidated financial statements for additional information. |
During the second quarter of 2016, we redeemed all outstanding shares of our Series A Preferred Stock, therefore we no longer pay Series A Preferred Stock dividends. See Note 17, Capital Stock, to the consolidated financial statements for additional information.
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Pension plan contributions were $330 million in 2017. We estimate that 2018 pension plan contributions will be approximately $50 million. Beyond 2018, 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 the timing of regulatory approval for the windup of certain non-U.S. pension plans, 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 2018 have been excluded from the above table.
Postretirement benefit plan contributions were $1.3 billion in 2017, including payments of $1.2 billion to pre-fund a portion of our U.S. postretirement plan benefits following enactment of U.S. Tax Reform on December 22, 2017. We estimate that 2018 postretirement benefit plan contributions will be approximately $15 million. Beyond 2018, 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 2018 have been excluded from the above table.
At December 30, 2017, 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 $428 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.
Equity and Dividends
Series A Preferred Stock Dividends:
On June 7, 2016, we redeemed all outstanding shares of our Series A Preferred Stock. Accordingly, we no longer pay any associated dividends, and there were no such dividend payments in 2017.
Prior to the redemption, we made cash distributions of $180 million in the second quarter of 2016 compared to $900 million in 2015. Our Series A Preferred Stock entitled holders to a 9.00% annual dividend, to be paid in four dividends, in arrears on each March 7, June 7, and December 7, in cash. In 2015, there were five dividend payments because, concurrent with the declaration of our common stock dividend on December 8, 2015, we also declared and paid the Series A Preferred Stock dividend that would otherwise have been payable on March 7, 2016. Accordingly, there were no cash distributions related to our Series A Preferred Stock in the first quarter of 2016, resulting in only one dividend payment in 2016 prior to redemption.
See Note 17, Capital Stock, to the consolidated financial statements for a discussion of the Series A Preferred Stock.
Common Stock Dividends:
We paid common stock dividends of $2.9 billion in 2017, $3.6 billion in 2016, and $1.3 billion in 2015. Additionally, on February 16, 2018, our Board of Directors declared a cash dividend of $0.625 per share of common stock, which is payable on March 23, 2018 to shareholders of record on March 9, 2018.
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.
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Supplemental Unaudited Pro Forma Condensed Combined Financial Information
The following unaudited pro forma condensed combined financial information is presented to illustrate the estimated effects of the 2015 Merger, which was consummated on July 2, 2015, and the related equity investments, based on the historical results of operations of Heinz and Kraft. See Note 1, Background and Basis of Presentation, and Note 2, Merger and Acquisition, to the consolidated financial statements for additional information on the 2015 Merger.
The following unaudited pro forma condensed combined statements of income for the year ended January 3, 2016 is based on the historical financial statements of Heinz and Kraft after giving effect to the 2015 Merger, related equity investments, and the assumptions and adjustments described in the accompanying notes to this unaudited pro forma condensed combined statement of income.
The Kraft Heinz statement of income information for the year ended January 3, 2016 was derived from the consolidated financial statements included elsewhere in this Form 10-K. The historical Kraft statement of income includes information for the six months ended June 27, 2015 derived from Kraft’s unaudited condensed consolidated financial statements included in our Current Report on Form 8-K filed with the SEC on July 7, 2016 and information for the period from June 27, 2015 to July 2, 2015 derived from Kraft’s books and records.
The unaudited pro forma condensed combined statements of income are presented as if the 2015 Merger had been consummated on December 30, 2013, the first business day of our 2014 fiscal year, and combine the historical results of Heinz and Kraft. This is consistent with internal management reporting. The unaudited pro forma condensed combined statements of income set forth below primarily give effect to the following assumptions and adjustments:
• | Application of the acquisition method of accounting; |
• | The issuance of Heinz common stock to the Sponsors in connection with the equity investments; |
• | The pre-closing Heinz share conversion; |
• | The exchange of one share of Kraft Heinz common stock for each share of Kraft common stock; and |
• | Conformance of accounting policies. |
The unaudited pro forma condensed combined financial information was prepared using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the completion of the acquisition. We utilized estimated fair values at the 2015 Merger Date to allocate the total consideration exchanged to the net tangible and intangible assets acquired and liabilities assumed. This allocation was final as of July 3, 2016.
The unaudited pro forma condensed combined financial information has been prepared in accordance with SEC Regulation S-X Article 11 and is not necessarily indicative of the results of operations that would have been realized had the transactions been completed as of the dates indicated, nor are they meant to be indicative of our anticipated combined future results. In addition, the accompanying unaudited pro forma condensed combined statements of income do not reflect any additional anticipated synergies, operating efficiencies, cost savings, or any integration costs that may result from the 2015 Merger.
The historical consolidated financial information has been adjusted in the accompanying unaudited pro forma condensed combined statements of income to give effect to unaudited pro forma events that are (1) directly attributable to the transaction, (2) factually supportable and (3) are expected to have a continuing impact on the results of operations of the combined company. As a result, under SEC Regulation S-X Article 11, certain expenses such as deal costs and non-cash costs related to the fair value step-up of inventory (“Inventory Step-up Costs”), if applicable, are eliminated from pro forma results in the periods presented. In contrast, under the ASC 805 presentation in Note 2, Merger and Acquisition, to the consolidated financial statements, these expenses are required to be included in prior year pro forma results.
The unaudited pro forma condensed combined financial information, including the related notes, should be read in conjunction with the historical consolidated financial statements and related notes of Kraft, and with our consolidated financial statements included elsewhere in this Form 10-K. The historical SEC filings of Kraft are available to the public at the SEC’s website at www.sec.gov.
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The Kraft Heinz Company
Pro Forma Condensed Combined Statements of Income
For the Year Ended January 3, 2016
(in millions, except per share data)
(Unaudited)
Kraft Heinz | Historical Kraft | Pro Forma Adjustments | Pro Forma | ||||||||||||
Net sales | $ | 18,338 | $ | 9,109 | $ | — | $ | 27,447 | |||||||
Cost of products sold | 12,577 | 6,103 | (381 | ) | 18,299 | ||||||||||
Gross profit | 5,761 | 3,006 | 381 | 9,148 | |||||||||||
Selling, general and administrative expenses | 3,122 | 1,532 | (41 | ) | 4,613 | ||||||||||
Operating income | 2,639 | 1,474 | 422 | 4,535 | |||||||||||
Interest expense | 1,321 | 247 | (40 | ) | 1,528 | ||||||||||
Other expense/(income), net | 305 | (16 | ) | — | 289 | ||||||||||
Income/(loss) before income taxes | 1,013 | 1,243 | 462 | 2,718 | |||||||||||
Provision for/(benefit from) income taxes | 366 | 400 | 178 | 944 | |||||||||||
Net income/(loss) | 647 | 843 | 284 | ||||||||||||