filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
Description of the Company:
We manufacture and market food and beverage products, including condiments and sauces, cheese and dairy, meals, meats, refreshment beverages, coffee, and other grocery products throughout the world.
In the first quarter of 2020, our internal reporting and reportable segments changed. We moved our Puerto Rico business from the Latin America zone to the United States zone to consolidate and streamline the management of our product categories and supply chain. We also combined our EMEA, Latin America, and APAC zones to form the International zone as a result of certain previously announced organizational changes.
Therefore, effective in the first quarter of 2020, we manage and report our operating results through three reportable segments defined by geographic region: United States, International, and Canada. We have reflected these changes in all historical periods presented.
See Note 22, Segment Reporting, in Item 8, Financial Statements and Supplementary Data, for our financial information by segment.
See below for discussion and analysis of our financial condition and results of operations for 2020 compared to 2019. See Item 7, Management’s Discussions and Analysis of Financial Condition and Results of Operations, in Exhibit 99.1, Updated portions of The Kraft Heinz Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2019, of our Current Report on Form 8-K filed with the SEC on November 13, 2020, for a detailed discussion of our financial condition and results of operations for 2019 compared to 2018.
Items Affecting Comparability of Financial Results
Impairment Losses:
Our results of operations reflect goodwill impairment losses of $2.3 billion and intangible asset impairment losses of $1.1 billion in 2020 compared to goodwill impairment losses of $1.2 billion and intangible asset impairment losses of $702 million in 2019. See Note 4, Acquisitions and Divestitures, and Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information on these impairment losses.
COVID-19 Impacts:
We have been actively monitoring the impact of COVID-19 on our business. In 2020, we experienced consolidated net sales growth compared to the prior year as higher demand for our retail products more than offset declines in our foodservice business. This increased demand for our retail products could reverse in the future if consumer purchasing behavior changes. We expect volatility in the demand for away-from-home establishments to continue through the first quarter of 2021 and potentially beyond, which is expected to negatively impact our foodservice business. However, COVID-19 and its impacts are unprecedented and continuously evolving, and the long-term impacts to our financial condition and results of operations are still uncertain.
See Consolidated Results of Operations and Liquidity and Capital Resources for additional information related to the impact of COVID-19 on our overall results. For information related to the impact of COVID-19 on our segment results see Results of Operations by Segment.
Results of Operations
We disclose in this report certain non-GAAP financial measures. These non-GAAP financial measures assist management in comparing our performance on a consistent basis for purposes of business decision-making by removing the impact of certain items that management believes do not directly reflect our underlying operations. For additional information and reconciliations from our consolidated financial statements see Non-GAAP Financial Measures.
Consolidated Results of Operations
Summary of Results:
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions, except per share data) | |||||||||||||||||
| Net sales | $ | 26,185 | $ | 24,977 | 4.8 | % | |||||||||||
| Operating income/(loss) | 2,128 | 3,070 | (30.7) | % | |||||||||||||
| Net income/(loss) attributable to common shareholders | 356 | 1,935 | (81.6) | % | |||||||||||||
| Diluted EPS | 0.29 | 1.58 | (81.6) | % |
Net Sales:
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions) | |||||||||||||||||
| Net sales | $ | 26,185 | $ | 24,977 | 4.8 | % | |||||||||||
| Organic Net Sales(a) | 26,320 | 24,718 | 6.5 | % |
(a) Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Net sales increased 4.8% to $26.2 billion in 2020 compared to $25.0 billion in 2019, despite the unfavorable impacts of divestitures (1.0 pp) and foreign currency (0.7 pp). Organic Net Sales increased 6.5% to $26.3 billion in 2020 compared to $24.7 billion in 2019, primarily driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic. Organic Net Sales growth was driven by favorable volume/mix (3.4 pp) and higher pricing (3.1 pp). Favorable volume/mix in the United States and International segments more than offset unfavorable volume/mix in Canada, while pricing was higher across all segments.
Net Income/(Loss):
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions) | |||||||||||||||||
| Operating income/(loss) | $ | 2,128 | $ | 3,070 | (30.7) | % | |||||||||||
| Net income/(loss) attributable to common shareholders | 356 | 1,935 | (81.6) | % | |||||||||||||
| Adjusted EBITDA(a) | 6,669 | 6,064 | 10.0 | % |
(a) Adjusted EBITDA is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Operating income/(loss) decreased 30.7% to income of $2.1 billion in 2020 compared to $3.1 billion in 2019, primarily driven by higher non-cash impairment losses in the current year. Non-cash impairment losses were $3.4 billion in 2020 compared to $1.9 billion in 2019. The remaining change in operating income/(loss) was an increase of $572 million, primarily driven by higher Organic Net Sales in the current year, which more than offset increased variable compensation expenses, higher equity award compensation expense, investments in marketing, higher supply chain costs, higher general corporate expenses, unfavorable changes in key commodity costs (which we define as dairy, meat, coffee, and nuts), and the unfavorable impact of divestitures. See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for additional information on our non-cash impairment losses.
Net income/(loss) attributable to common shareholders decreased 81.6% to income of $356 million in 2020 compared to $1.9 billion in 2019. This change was driven by the operating income/(loss) factors described above (primarily higher non-cash impairment losses in the current year), unfavorable changes in other expense/(income), and higher interest expense, partially offset by lower tax expense in the current year.
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Other expense/(income) was $296 million of income in 2020 compared to $952 million of income in 2019. This change was primarily driven by a $2 million net loss on sales of businesses in 2020 compared to a $420 million net gain on sales of businesses in 2019, a $184 million decrease in non-cash amortization of prior service credits as compared to the prior year period, a $162 million net foreign exchange loss in 2020 compared to a $10 million net foreign exchange loss in 2019, and a $26 million loss on the dissolution of a joint venture. These impacts were partially offset by a $154 million net gain on derivative activities in 2020 compared to a $33 million net gain on derivative activities in 2019. As we estimate the amortization of prior service credits to be insignificant in 2021, we are forecasting a negative impact to other expense/(income) in 2021 compared to 2020 of approximately $114 million.
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Interest expense was $1.4 billion in 2020 compared to $1.4 billion in 2019. Our 2020 interest expense included a $124 million loss on extinguishment of debt recognized in connection with our tender offer and debt redemptions in 2020, as well as $22 million of interest expense related to the $4.0 billion drawn on our Senior Credit Facility in the first quarter of 2020 and repaid by the end of the second quarter of 2020. Our 2019 interest expense included a $98 million loss on extinguishment of debt recognized in connection with our tender offers and debt redemptions in 2019.
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Our effective tax rate was 65.0% in 2020 compared to 27.4% in 2019. Our 2020 effective tax rate was unfavorably impacted by rate reconciling items, primarily related to non-deductible goodwill impairments, the impact of the federal tax on global intangible low-taxed income (“GILTI”), and the revaluation of our deferred tax balances due to changes in international tax laws. These impacts were partially offset by a more favorable geographic mix of pre-tax income in various non-U.S. jurisdictions and the favorable impact of establishing certain deferred tax assets for state tax deductions. Our 2019 effective tax rate was unfavorably impacted by rate reconciling items, primarily related to non-deductible goodwill impairments, the impact of the federal tax on GILTI, an increase in uncertain tax position reserves, the establishment of certain state valuation allowance reserves, and the tax impacts from the sale of Heinz India Private Limited (“Heinz India Transaction”) and the sale of certain assets in our natural cheese business in Canada (“Canada Natural Cheese Transaction”). These impacts were partially offset by the reversal of certain withholding tax obligations and changes in estimates of certain 2018 U.S. income and deductions.
Adjusted EBITDA increased 10.0% to $6.7 billion in 2020 compared to $6.1 billion in 2019, despite the unfavorable impacts of divestitures (1.0 pp) and foreign currency (0.5 pp), as increases in the United States and International segments more than offset declines in Canada and higher general corporate expenses. Adjusted EBITDA growth was primarily driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic.
Diluted EPS:
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions, except per share data) | |||||||||||||||||
| Diluted EPS | $ | 0.29 | $ | 1.58 | (81.6) | % | |||||||||||
| Adjusted EPS(a) | 2.88 | 2.85 | 1.1 | % |
(a) Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Diluted EPS decreased 81.6% to $0.29 in 2020 compared to $1.58 in 2019, primarily driven by the net income/(loss) attributable to common shareholders factors discussed above.
| December 26, 2020 | December 28, 2019 | $ Change | % Change | ||||||||||||||||||||
| Diluted EPS | $ | 0.29 | $ | 1.58 | $ | (1.29) | (81.6) | % | |||||||||||||||
| Integration and restructuring expenses | — | 0.07 | (0.07) | ||||||||||||||||||||
| Deal costs | — | 0.02 | (0.02) | ||||||||||||||||||||
| Unrealized losses/(gains) on commodity hedges | — | (0.04) | 0.04 | ||||||||||||||||||||
| Impairment losses | 2.59 | 1.38 | 1.21 | ||||||||||||||||||||
| Losses/(gains) on sale of business | (0.01) | (0.23) | 0.22 | ||||||||||||||||||||
| Nonmonetary currency devaluation | — | 0.01 | (0.01) | ||||||||||||||||||||
| Debt prepayment and extinguishment costs | 0.08 | 0.06 | 0.02 | ||||||||||||||||||||
| U.S. Tax Reform discrete income tax expense/(benefit) | (0.07) | — | (0.07) | ||||||||||||||||||||
| Adjusted EPS(a) | $ | 2.88 | $ | 2.85 | $ | 0.03 | 1.1 | % | |||||||||||||||
| Key drivers of change in Adjusted EPS(a): | |||||||||||||||||||||||
| Results of operations | $ | 0.39 | |||||||||||||||||||||
| Results of divested operations | (0.04) | ||||||||||||||||||||||
| Interest expense | (0.01) | ||||||||||||||||||||||
| Other expense/(income) | (0.17) | ||||||||||||||||||||||
| Effective tax rate and other | (0.14) | ||||||||||||||||||||||
| $ | 0.03 |
(a) Adjusted EPS is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Adjusted EPS increased 1.1% to $2.88 in 2020 compared to $2.85 in 2019 primarily due to higher Adjusted EBITDA, which more than offset unfavorable changes in other expense/(income), higher taxes on adjusted earnings in the current period, and higher equity award compensation expense. Unfavorable changes in other expense/(income) were primarily due to lower non-cash amortization of prior service credits in the current year.
Results of Operations by Segment
Management evaluates segment performance based on several factors, including net sales, Organic Net Sales, and Segment Adjusted EBITDA. Segment Adjusted EBITDA is defined as net income/(loss) from continuing operations before interest expense, other expense/(income), provision for/(benefit from) income taxes, and depreciation and amortization (excluding integration and restructuring expenses); in addition to these adjustments, we exclude, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized gains/(losses) on commodity hedges (the unrealized gains and losses are recorded in general corporate expenses until realized; once realized, the gains and losses are recorded in the applicable segment’s operating results), impairment losses, and equity award compensation expense (excluding integration and restructuring expenses). Segment Adjusted EBITDA is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Under highly inflationary accounting, the financial statements of a subsidiary are remeasured into our reporting currency (U.S. dollars) based on the legally available exchange rate at which we expect to settle the underlying transactions. Exchange gains and losses from the remeasurement of monetary assets and liabilities are reflected in net income/(loss), rather than accumulated other comprehensive income/(losses) on the balance sheet, until such time as the economy is no longer considered highly inflationary. The exchange gains and losses from remeasurement are recorded in current net income/(loss) and are classified within other expense/(income), as nonmonetary currency devaluation. See Note 15, Venezuela - Foreign Currency and Inflation, and Note 2, Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data, for additional information.
Net Sales:
| December 26, 2020 | December 28, 2019 | ||||||||||
| (in millions) | |||||||||||
| Net sales: | |||||||||||
| United States | $ | 19,204 | $ | 17,844 | |||||||
| International | 5,341 | 5,251 | |||||||||
| Canada | 1,640 | 1,882 | |||||||||
| Total net sales | $ | 26,185 | $ | 24,977 |
Organic Net Sales:
| 2020 Compared to 2019 | |||||||||||
| December 26, 2020 | December 28, 2019 | ||||||||||
| (in millions) | |||||||||||
| Organic Net Sales(a): | |||||||||||
| United States | $ | 19,204 | $ | 17,844 | |||||||
| International | 5,455 | 5,211 | |||||||||
| Canada | 1,661 | 1,663 | |||||||||
| Total Organic Net Sales | $ | 26,320 | $ | 24,718 |
(a) Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Drivers of the changes in net sales and Organic Net Sales were:
| Net Sales | Currency | Acquisitions and Divestitures | Organic Net Sales | Price | Volume/Mix | ||||||||||||||||||||||||||||||
| 2020 Compared to 2019 | |||||||||||||||||||||||||||||||||||
| United States | 7.6 | % | 0.0 pp | 0.0 pp | 7.6 | % | 3.5 pp | 4.1 pp | |||||||||||||||||||||||||||
| International | 1.7 | % | (2.7) pp | (0.3) pp | 4.7 | % | 2.1 pp | 2.6 pp | |||||||||||||||||||||||||||
| Canada | (12.8) | % | (1.1) pp | (11.6) pp | (0.1) | % | 2.2 pp | (2.3) pp | |||||||||||||||||||||||||||
| Kraft Heinz | 4.8 | % | (0.7) pp | (1.0) pp | 6.5 | % | 3.1 pp | 3.4 pp |
Adjusted EBITDA:
| December 26, 2020 | December 28, 2019 | ||||||||||
| (in millions) | |||||||||||
| Segment Adjusted EBITDA: | |||||||||||
| United States | $ | 5,557 | $ | 4,829 | |||||||
| International | 1,058 | 1,004 | |||||||||
| Canada | 389 | 487 | |||||||||
| General corporate expenses | (335) | (256) | |||||||||
| Depreciation and amortization (excluding integration and restructuring expenses) | (955) | (985) | |||||||||
| Integration and restructuring expenses | (15) | (102) | |||||||||
| Deal costs | (8) | (19) | |||||||||
| Unrealized gains/(losses) on commodity hedges | 6 | 57 | |||||||||
| Impairment losses | (3,413) | (1,899) | |||||||||
| Equity award compensation expense (excluding integration and restructuring expenses) | (156) | (46) | |||||||||
| Operating income/(loss) | 2,128 | 3,070 | |||||||||
| Interest expense | 1,394 | 1,361 | |||||||||
| Other expense/(income) | (296) | (952) | |||||||||
| Income/(loss) before income taxes | $ | 1,030 | $ | 2,661 |
United States:
| 2020 Compared to 2019 | |||||||||||||||||
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions) | |||||||||||||||||
| Net sales | $ | 19,204 | $ | 17,844 | 7.6 | % | |||||||||||
| Organic Net Sales(a) | 19,204 | 17,844 | 7.6 | % | |||||||||||||
| Segment Adjusted EBITDA | 5,557 | 4,829 | 15.1 | % |
(a) Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Net sales and Organic Net Sales both increased 7.6% to $19.2 billion in 2020 compared to $17.8 billion in 2019, driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic. Organic Net Sales growth was driven by favorable volume/mix (4.1 pp) and higher pricing (3.5 pp). Favorable volume/mix was primarily driven by consumption growth across nearly all retail categories, most significantly in condiments and sauces, cheese, and boxed dinners. This growth was partially offset by lower foodservice sales and the negative impact from exiting the McCafé licensing agreement. Higher pricing was primarily driven by reduced promotional activity, primarily in capacity-constrained areas, higher list prices in select categories, and increases to offset unfavorable key commodity costs, primarily in dairy.
Segment Adjusted EBITDA increased 15.1% to $5.6 billion in 2020 compared to $4.8 billion in 2019. This increase was primarily driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic, as pricing gains, increased volume and favorable product and channel mix, and productivity savings more than offset manufacturing and logistics cost inflation, increased variable compensation expenses, investments in marketing, COVID-19-related operating costs, and unfavorable changes in key commodity costs.
International:
| 2020 Compared to 2019 | |||||||||||||||||
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions) | |||||||||||||||||
| Net sales | $ | 5,341 | $ | 5,251 | 1.7 | % | |||||||||||
| Organic Net Sales(a) | 5,455 | 5,211 | 4.7 | % | |||||||||||||
| Segment Adjusted EBITDA | 1,058 | 1,004 | 5.4 | % |
(a) Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Net sales increased 1.7% to $5.3 billion in 2020 compared to $5.3 billion in 2019, despite the unfavorable impacts of foreign currency (2.7 pp, including 0.5 pp from the devaluation of the Venezuelan bolivar) and divestitures (0.3 pp). Organic Net Sales increased 4.7% to $5.5 billion in 2020 compared to $5.2 billion in 2019, driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic. Organic Net Sales growth was driven by favorable volume/mix (2.6 pp) and higher pricing (2.1 pp). Favorable volume/mix was primarily driven by consumption-led growth in condiments and sauces and boxed dinners, which more than offset a significant decline in foodservice-related sales and, to a lesser extent, infant nutrition shipments. Higher pricing was primarily driven by increases in Latin America, Australia, and the United Kingdom.
Segment Adjusted EBITDA increased 5.4% to $1.1 billion in 2020 compared to $1.0 billion in 2019. This increase was primarily driven by the continued growth of at-home consumption due, in part, to the COVID-19 pandemic, as Organic Net Sales growth more than offset higher supply chain costs, increased variable compensation expenses, and the unfavorable impact of foreign currency (2.4 pp, including 1.4 pp from the devaluation of the Venezuelan bolivar).
Canada:
| 2020 Compared to 2019 | |||||||||||||||||
| December 26, 2020 | December 28, 2019 | % Change | |||||||||||||||
| (in millions) | |||||||||||||||||
| Net sales | $ | 1,640 | $ | 1,882 | (12.8) | % | |||||||||||
| Organic Net Sales(a) | 1,661 | 1,663 | (0.1) | % | |||||||||||||
| Segment Adjusted EBITDA | 389 | 487 | (20.2) | % |
(a) Organic Net Sales is a non-GAAP financial measure. See the Non-GAAP Financial Measures section at the end of this item.
Fiscal Year 2020 Compared to Fiscal Year 2019:
Net sales decreased 12.8% to $1.6 billion in 2020 compared to $1.9 billion in 2019, primarily due to the unfavorable impacts of divestitures (11.6 pp) and foreign currency (1.1 pp). Organic Net Sales decreased 0.1% to $1.7 billion in 2020 compared to $1.7 billion in 2019, primarily due to unfavorable volume/mix (2.3 pp), which more than offset higher pricing (2.2 pp). Unfavorable volume/mix was primarily due to lower foodservice-related sales and the negative impact from exiting the McCafé licensing agreement, which more than offset the continued growth of at-home consumption due, in part, to the COVID-19 pandemic. Pricing was higher primarily driven by price increases in cheese.
Segment Adjusted EBITDA decreased 20.2% to $389 million in 2020 compared to $487 million in 2019, despite the continued growth of at-home consumption due, in part, to the COVID-19 pandemic. Segment Adjusted EBITDA decreased primarily due to the unfavorable impact of divestitures (10.6 pp), higher supply chain costs, the negative impact from exiting the McCafé licensing agreement, as well as the unfavorable impact of foreign currency (1.0 pp), which more than offset pricing gains compared to the prior year period.
Critical Accounting Estimates
Note 2, Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data, includes a summary of the significant accounting policies we used to prepare our consolidated financial statements. The following is a review of the more significant assumptions and estimates as well as accounting policies we used to prepare our consolidated financial statements.
Revenue Recognition:
Our revenues are primarily derived from customer orders for the purchase of our products. We recognize revenues as performance obligations are fulfilled when control passes to our customers. We record revenues net of variable consideration, including consumer incentives and performance obligations related to trade promotions, excluding taxes, and including all shipping and handling charges billed to customers (accounting for shipping and handling charges that occur after the transfer of control as fulfillment costs). We also record a refund liability for estimated product returns and customer allowances as reductions to revenues within the same period that the revenue is recognized. We base these estimates principally on historical and current period experience factors. We recognize costs paid to third party brokers to obtain contracts as expenses as our contracts are generally less than one year.
Advertising, Consumer Incentives, and Trade Promotions:
We promote our products with advertising, consumer incentives, and performance obligations related to trade promotions. Consumer incentives and trade promotions include, but are not limited to, discounts, coupons, rebates, performance-based in-store display activities, and volume-based incentives. Variable consideration related to consumer incentive and trade promotion activities is recorded as a reduction to revenues based on amounts estimated as being due to customers and consumers at the end of a period. We base these estimates principally on historical utilization, redemption rates, and/or current period experience factors. We review and adjust these estimates at least quarterly based on actual experience and other information.
Advertising expenses are recorded in selling, general and administrative expenses (“SG&A”). For interim reporting purposes, we charge advertising to operations as a percentage of estimated full year sales activity and marketing costs. We then review and adjust these estimates each quarter based on actual experience and other information. We recorded advertising expenses of $646 million in 2020, $534 million in 2019, and $584 million in 2018, which represented costs to obtain physical advertisement spots in television, radio, print, digital, and social channels. We also incur other advertising and marketing costs such as shopper marketing, sponsorships, and agency advertisement conception, design, and public relations fees. Total advertising and marketing costs were $1.2 billion in 2020 and $1.1 billion in both 2019 and 2018.
Goodwill and Intangible Assets:
As of December 26, 2020, we maintain 15 reporting units, nine of which comprise our goodwill balance. These nine reporting units had an aggregate carrying amount of $33.1 billion as of December 26, 2020. Our indefinite-lived intangible asset balance
primarily consists of a number of individual brands, which had an aggregate carrying amount of $42.3 billion as of December 26, 2020.
We test our reporting units and brands for impairment annually as of the first day of our second quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit or brand is less than its carrying amount. Such events and circumstances could include a sustained decrease in our market capitalization, increased competition or unexpected loss of market share, increased input costs beyond projections (for example due to regulatory or industry changes), disposals of significant brands or components of our business, unexpected business disruptions (for example due to a natural disaster, pandemic, or loss of a customer, supplier, or other significant business relationship), unexpected significant declines in operating results, significant adverse changes in the markets in which we operate, or changes in management strategy. We test reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. We test brands for impairment by comparing the estimated fair value of each brand with its carrying amount. If the carrying amount of a reporting unit or brand exceeds its estimated fair value, we record an impairment loss based on the difference between fair value and carrying amount, in the case of reporting units, not to exceed the associated carrying amount of goodwill.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units and brands requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax considerations, discount rates, growth rates, royalty rates, contributory asset charges, and other market factors. If current expectations of future growth rates and margins are not met, if market factors outside of our control, such as discount rates, income tax rates, foreign currency exchange rates, or any factors that could be affected by COVID-19, change, or if management’s expectations or plans otherwise change, including updates to our long-term operating plans, then one or more of our reporting units or brands might become impaired in the future. Additionally, any decisions to divest certain non-strategic assets could lead to the impairment of one or more of our reporting units or brands in the future.
In 2020, the COVID-19 pandemic produced a short-term beneficial financial impact for our consolidated results. Retail sales increased due to higher than anticipated consumer demand for our products. The foodservice channel, however, experienced a negative impact from prolonged social distancing mandates limiting access to and capacity at away-from-home establishments for a longer period of time than was expected when they were originally put in place. Our ESA and Canada Foodservice reporting units are the most exposed of our reporting units to the long-term impacts to away-from-home establishments. Our U.S. Foodservice (now included within ESA) and Canada Foodservice reporting units were both impaired during our most recent annual impairment test, reflecting our best estimate at that time of the future outlook and risks of these businesses. The ESA and Canada Foodservice reporting units maintain an aggregate goodwill carrying amount of approximately $11.7 billion as of December 26, 2020. A number of factors could result in further future impairments of our foodservice businesses, including but not limited to: continued mandates around closures of dining rooms in restaurants, distancing of people within establishments resulting in fewer customers, the total number of restaurant closures, forthcoming changes in consumer preferences or regulatory requirements over product formats (e.g., table top packaging vs. single serve packaging), and consumer trends of dining-in versus dining-out. Given the evolving nature of and uncertainty driven by the COVID-19 pandemic, we will continue to evaluate the impact on our reporting units as adverse changes to these assumptions could result in future impairments.
As we consider the ongoing impact of the COVID-19 pandemic with regard to our indefinite-lived intangible assets, a number of factors could have a future adverse impact on our brands, including changes in consumer and consumption trends in both the short and long term, the extent of continued government mandates to shelter in place, total number of restaurant closures, economic declines, and reductions in consumer discretionary income. We have seen an increase in our retail business in the short-term that has more than offset declines in our foodservice business over the same period. Our brands are generally common across both the retail and foodservice businesses and the fair value of our brands are subject to a similar mix of positive and negative factors. Given the evolving nature and uncertainty driven by COVID-19 pandemic, we will continue to evaluate the impact on our brands.
As detailed in Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, we recorded impairment losses related to goodwill and indefinite-lived intangible assets. Our reporting units and brands that were impaired were written down to their respective fair values resulting in zero excess fair value over carrying amount as of the applicable impairment test dates. Accordingly, these and other reporting units and brands that have 20% or less excess fair value over carrying amount as of their latest 2020 impairment testing date have a heightened risk of future impairments if any assumptions, estimates, or market factors change in the future.
Reporting units with 10% or less fair value over carrying amount had an aggregate goodwill carrying amount of $7.5 billion as of their latest 2020 impairment testing date and included: MFC, Canada Retail, Canada Foodservice, and Puerto Rico. Reporting units with between 10-20% fair value over carrying amount had an aggregate goodwill carrying amount of $12.5 billion as of their latest 2020 impairment testing date and included: KSB and Northern Europe. Reporting units with between 20-50% fair value over carrying amount had an aggregate goodwill carrying amount of $12.5 billion as of their latest 2020 impairment testing date and included: ESA and Continental Europe. The Asia reporting unit had a fair value over carrying amount in excess of 50% and a goodwill carrying amount of $326 million as of its latest 2020 impairment testing date. Brands with 10% or less fair value over carrying amount had an aggregate carrying amount after impairment of $21.8 billion as of their latest 2020 impairment testing date and included: Kraft, Oscar Mayer, Velveeta, Miracle Whip, Planters, Maxwell House, Cool Whip, Classico, ABC, Plasmon, and Wattie’s (each of these brands had a fair value over carrying amount of less than 1% due to impairments recorded in the current and recent prior years). Brands with 10-20% fair value over carrying amount had an aggregate carrying amount of $4.1 billion as of their latest 2020 impairment testing date and included: Lunchables, A1, Ore-Ida, Stove Top, Jet Puffed, and Quero. The aggregate carrying amount of brands with fair value over carrying amount between 20-50% was $6.6 billion as of their latest 2020 impairment testing date. Although the remaining brands, with an aggregate carrying amount of $9.3 billion, have more than 50% excess fair value over carrying amount as of their latest 2020 impairment testing date, these amounts are also associated with the acquisition of H. J. Heinz Company by the Sponsors in 2013 and the 2015 Merger and are recorded on the balance sheet at their estimated acquisition date fair values. Therefore, if any assumptions, estimates, or market factors change in the future, these amounts are also susceptible to impairments.
We generally utilize the discounted cash flow method under the income approach to estimate the fair value of our reporting units. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each reporting unit (including net sales, cost of products sold, SG&A, depreciation and amortization, working capital, and capital expenditures), income tax rates, long-term growth rates, and a discount rate that appropriately reflects the risks inherent in each future cash flow stream. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
We utilize the excess earnings method under the income approach to estimate the fair value of certain of our largest brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each brand (including net sales, cost of products sold, and SG&A), contributory asset charges, income tax considerations, long-term growth rates, a discount rate that reflects the level of risk associated with the future earnings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
We utilize the relief from royalty method under the income approach to estimate the fair value of our remaining brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net sales for each brand, royalty rates (as a percentage of net sales that would hypothetically be charged by a licensor of the brand to an unrelated licensee), income tax considerations, long-term growth rates, a discount rate that reflects the level of risk associated with the future cost savings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management’s plans, and guideline companies.
As detailed in Note 4, Acquisitions and Divestitures, in Item 8, Financial Statements and Supplementary Data, in the third quarter of 2020, we entered into a definitive agreement with an affiliate of Groupe Lactalis (“Lactalis”) to sell certain assets in our global cheese business, as well as to license certain trademarks, for total consideration of approximately $3.3 billion (the “Cheese Transaction”). The total consideration includes approximately $1.5 billion attributed to the Kraft and Velveeta licenses that we will grant to Lactalis and approximately $75 million attributed to the Cracker Barrel license that Lactalis will grant to us, the amounts of which were based on the estimated fair values of the licensed portion of each brand. We utilized the excess earnings method under the income approach to estimate the fair value of the licensed portion of the Kraft brand and the relief from royalty method under the income approach to estimate the fair value of the licensed portions of the Velveeta brand and the Cracker Barrel brand. Some of the more significant assumptions inherent in estimating these fair values include the estimated future annual net sales and net cash flows for each brand, contributory asset charges, royalty rates (as a percentage of net sales that would hypothetically be charged by a licensor of the brand to an unrelated licensee), income tax considerations, long-term growth rates, and a discount rate that reflects the level of risk associated with the future earnings attributable to each brand. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, and guideline companies. As of December 26, 2020, we assessed the fair value less costs to sell of the net assets to be transferred to Lactalis and determined that their estimated fair value exceeded their carrying amount.
At the time the licensed rights are granted, we will reassess the remaining fair value of the retained portions of the Kraft and Velveeta brands and may record a charge to reduce the intangible asset carrying amounts to reflect the lower future cash flows expected to be generated after monetization of the licensed portion of each brand. Any potential reduction to the intangible asset carrying amounts will depend upon the excess fair value, if any, over carrying amount for each brand at the time we grant the perpetual licenses, which will be on the closing date of the Cheese Transaction. Changes in the fair value of the retained and licensed portions of each brand will impact the amount of any potential charges and the amount of license income that will be recognized, which, at this time, we would not expect to exceed the fair value of the perpetual licenses.
The discount rates, long-term growth rates, and royalty rates used to estimate the fair values of our reporting units and our brands with 10% or less excess fair value over carrying amount, as well as the goodwill or brand carrying amounts, as of the latest 2020 impairment testing date for each reporting unit or brand, were as follows:
| Goodwill or Brand Carrying Amount (in billions) | Discount Rate | Long-Term Growth Rate | Royalty Rate | ||||||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Minimum | Maximum | Minimum | Maximum | ||||||||||||||||||||||||||||||||||||
| Reporting units | $ | 7.5 | 6.5 | % | 6.8 | % | 0.5 | % | 1.8 | % | |||||||||||||||||||||||||||||||
| Brands (excess earnings method) | 16.3 | 7.0 | % | 7.8 | % | 0.8 | % | 1.5 | % | ||||||||||||||||||||||||||||||||
| Brands (relief from royalty method) | 5.5 | 7.1 | % | 9.0 | % | 0.5 | % | 4.0 | % | 5.0 | % | 20.0 | % |
The discount rates, long-term growth rates, and royalty rates used to estimate the fair values of our reporting units and our brands with 10-20% excess fair value over carry amount, as well as the goodwill or brand carrying amounts, as of the latest 2020 impairment testing date for each reporting unit or brand, were as follows:
| Goodwill or Brand Carrying Amount (in billions) | Discount Rate | Long-Term Growth Rate | Royalty Rate | ||||||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Minimum | Maximum | Minimum | Maximum | ||||||||||||||||||||||||||||||||||||
| Reporting units | $ | 12.5 | 6.8 | % | 7.0 | % | 1.0 | % | 1.5 | % | |||||||||||||||||||||||||||||||
| Brands (excess earnings method) | 1.4 | 7.5 | % | 7.5 | % | 1.0 | % | 1.0 | % | ||||||||||||||||||||||||||||||||
| Brands (relief from royalty method) | 2.7 | 7.0 | % | 8.0 | % | 1.5 | % | 3.0 | % | 1.0 | % | 20.0 | % |
Assumptions used in impairment testing are made at a point in time and require significant judgment; therefore, they are subject to change based on the facts and circumstances present at each annual and interim impairment test date. Additionally, these assumptions are generally interdependent and do not change in isolation. However, as it is reasonably possible that changes in assumptions could occur, as a sensitivity measure, we have presented the estimated effects of isolated changes in discount rates, long-term growth rates, and royalty rates on the fair values of our reporting units and brands with 10% or less excess fair value over carrying amount and 10-20% excess fair value over carrying amount. These estimated changes in fair value are not necessarily representative of the actual impairment that would be recorded in the event of a fair value decline.
If we had changed the assumptions used to estimate the fair value of our reporting units and our brands with 10% or less excess fair value over carrying amount, as of the latest 2020 impairment testing date for each of these reporting units and brands, these isolated changes, which are reasonably possible to occur, would have led to the following increase/(decrease) in the aggregate fair value of these reporting units and brands (in billions):
| Discount Rate | Long-Term Growth Rate | Royalty Rate | |||||||||||||||||||||||||||||||||
| 50-Basis-Point | 25-Basis-Point | 100-Basis-Point | |||||||||||||||||||||||||||||||||
| Increase | Decrease | Increase | Decrease | Increase | Decrease | ||||||||||||||||||||||||||||||
| Reporting units | $ | (2.1) | $ | 2.6 | $ | 1.1 | $ | (1.0) | |||||||||||||||||||||||||||
| Brands (excess earnings method) | (1.1) | 1.3 | 0.5 | (0.5) | |||||||||||||||||||||||||||||||
| Brands (relief from royalty method) | (0.3) | 0.4 | 0.2 | (0.2) | $ | 0.4 | $ | (0.4) |
If we had changed the assumptions used to estimate the fair value of our reporting units and our brands with 10-20% excess fair value over carrying amount, as of the latest 2020 impairment testing date for each of these reporting units and brands, these isolated changes, which are reasonably possible to occur, would have led to the following increase/(decrease) in the aggregate fair value of these reporting units and brands (in billions):
| Discount Rate | Long-Term Growth Rate | Royalty Rate | |||||||||||||||||||||||||||||||||
| 50-Basis-Point | 100-Basis-Point | ||||||||||||||||||||||||||||||||||
| Increase | Decrease | Increase | Decrease | Increase | Decrease | ||||||||||||||||||||||||||||||
| Reporting units | $ | (2.3) | $ | 2.8 | $ | 1.1 | $ | (1.0) | |||||||||||||||||||||||||||
| Brands (excess earnings method) | (0.1) | 0.1 | — | — | |||||||||||||||||||||||||||||||
| Brands (relief from royalty method) | (0.2) | 0.3 | 0.1 | (0.1) | $ | 0.3 | $ | (0.3) |
Definite-lived intangible assets are amortized on a straight-line basis over the estimated periods benefited. We review definite-lived intangible assets for impairment when conditions exist that indicate the carrying amount of the assets may not be recoverable. Such conditions could include significant adverse changes in the business climate, current-period operating or cash flow losses, significant declines in forecasted operations, or a current expectation that an asset group will be disposed of before the end of its useful life. We perform undiscounted operating cash flow analyses to determine if an impairment exists. When testing for impairment of definite-lived intangible assets held for use, we group assets at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, the loss is calculated based on estimated fair value. Impairment losses on definite-lived intangible assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
See Note 9, Goodwill and Intangible Assets, in Item 8, Financial Statements and Supplementary Data, for our impairment testing results.
Postemployment Benefit Plans:
We maintain various retirement plans for the majority of our employees. These include pension benefits, postretirement health care benefits, and defined contribution benefits. The cost of these plans is charged to expense over an appropriate term based on, among other things, the cost component and whether the plan is active or inactive. Changes in the fair value of our plan assets result in net actuarial gains or losses. These net actuarial gains and losses are deferred into accumulated other comprehensive income/(losses) and amortized within other expense/(income) in future periods using the corridor approach. The corridor is 10% of the greater of the market-related value of the plan’s asset or projected benefit obligation. Any actuarial gains and losses in excess of the corridor are then amortized over an appropriate term based on whether the plan is active or inactive.
For our postretirement benefit plans, our 2021 health care cost trend rate assumption will be 6.2%. 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 4.8%. The year in which the ultimate trend rate is reached varies by plan, ranging between the years 2021 and 2030. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans.
Our 2021 discount rate assumption will be 2.7% for service cost and 1.6% for interest cost for our postretirement plans. Our 2021 discount rate assumption will be 3.0% for service cost and 2.1% for interest cost for our U.S. pension plans and 2.1% for service cost and 1.2% 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.
Our 2021 expected return on plan assets will be 4.4% (net of applicable taxes) for our postretirement plans. Our 2021 expected rate of return on plan assets will be 4.1% for our U.S. pension plans and 3.1% 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 2021 assumptions for our U.S. and non-U.S. pension and postretirement benefit plans, as a sensitivity measure, a 100-basis-point change in our discount rate or a 100-basis-point change in the expected rate of return on plan assets would have the following effects, increase/(decrease) in cost (in millions):
| U.S. Plans | Non-U.S. Plans | ||||||||||||||||||||||
| 100-Basis-Point | 100-Basis-Point | ||||||||||||||||||||||
| Increase | Decrease | Increase | Decrease | ||||||||||||||||||||
| Effect of change in discount rate on pension costs | $ | 13 | $ | (29) | $ | 11 | $ | (4) | |||||||||||||||
| Effect of change in expected rate of return on plan assets on pension costs | (45) | 45 | (30) | 30 | |||||||||||||||||||
| Effect of change in discount rate on postretirement costs | (6) | 6 | (1) | (1) | |||||||||||||||||||
| Effect of change in expected rate of return on plan assets on postretirement costs | (11) | 11 | — | — |
Income Taxes:
We compute our annual tax rate based on the statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we earn income. Significant judgment is required in determining our annual tax rate and in evaluating the uncertainty of our tax positions. We recognize a benefit for tax positions that we believe will more likely than not be sustained upon examination. The amount of benefit recognized is the largest amount of benefit that we believe has more than a 50% probability of being realized upon settlement. We regularly monitor our tax positions and adjust the amount of recognized tax benefit based on our evaluation of information that has become available since the end of our last financial reporting period. The annual tax rate includes the impact of these changes in recognized tax benefits. When adjusting the amount of recognized tax benefits, we do not consider information that has become available after the balance sheet date, however we do disclose the effects of new information whenever those effects would be material to our financial statements. Unrecognized tax benefits represent the difference between the amount of benefit taken or expected to be taken in a tax return and the amount of benefit recognized for financial reporting. These unrecognized tax benefits are recorded primarily within other non-current liabilities on the consolidated balance sheets.
We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. When assessing the need for valuation allowances, we consider future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, we would adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or decrease to income. The resolution of tax reserves and changes in valuation allowances could be material to our results of operations for any period but is not expected to be material to our financial position.
New Accounting Pronouncements
See Note 3, New Accounting Standards, in Item 8, Financial Statements and Supplementary Data, for a discussion of new accounting pronouncements.
Contingencies
See Note 17, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data, for a discussion of our contingencies.
Commodity Trends
We purchase and use large quantities of commodities, including dairy products, meat products, coffee beans, nuts, tomatoes, potatoes, soybean and vegetable oils, sugar and other sweeteners, corn products, wheat products, and cocoa products, to manufacture our products. In addition, we purchase and use significant quantities of resins, metals, and cardboard to package our products, and we use natural gas, electricity, and diesel fuel in the manufacturing and distribution of our products. 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 2020, we experienced cost increases for dairy and meat, while costs for nuts and coffee decreased. We manage commodity cost volatility primarily through pricing and risk management strategies. As a result of these risk management strategies, our commodity costs may not immediately correlate with market price trends.
Dairy commodities, primarily milk and cheese, are the most significant cost components of our cheese products. We purchase our dairy raw material requirements from independent third parties, such as agricultural cooperatives and independent processors. Market supply and demand, as well as government programs, significantly influence the prices for milk and other dairy products. Significant cost components of our meat products include pork, beef, and poultry, which we primarily purchase from applicable local markets. Livestock feed costs and the global supply and demand for U.S. meats influence the prices of these meat products. The most significant cost component of our coffee products is coffee beans, which we purchase on global markets. Quality and availability of supply, currency fluctuations, and consumer demand for coffee products impact coffee bean prices. The most significant cost components in our nut products include peanuts, cashews, and almonds, which we purchase on both domestic and global markets, where global market supply and demand is the primary driver of prices.
Liquidity and Capital Resources
In February 2020, Fitch and S&P downgraded our long-term credit rating from BBB- to BB+. These downgrades adversely affect our ability to access the commercial paper market. In addition, we could experience an increase in interest costs as a result of the downgrades. These downgrades do not constitute a default or event of default under any of our debt instruments. Limitations on or elimination of our ability to access the commercial paper program may require us to borrow under the Senior Credit Facility, if necessary to meet liquidity needs. Our ability to borrow under the Senior Credit Facility is not affected by the downgrades. As of the date of this filing, our long-term debt is rated BB+ by both Fitch and S&P and Baa3 by Moody’s, with a positive outlook from Fitch and a stable outlook from Moody’s and S&P.
On March 12, 2020, we provided notice to our lenders to borrow the full available amount under our Senior Credit Facility so that a total of $4.0 billion was drawn in the first quarter of 2020. This action was a precautionary measure to preserve financial flexibility in light of the uncertainty in the global economy resulting from the COVID-19 pandemic. We repaid the full $4.0 billion revolver draw during the second quarter of 2020.
We believe that cash generated from our operating activities and Senior Credit Facility will provide sufficient liquidity to meet our working capital needs, repayments of long-term debt, future contractual obligations, payment of our anticipated quarterly dividends, planned capital expenditures, restructuring expenditures, and contributions to our postemployment benefit plans for the next 12 months. An additional potential source of liquidity is access to capital markets. We intend to use our cash on hand for daily funding requirements.
Cash Flow Activity for 2020 Compared to 2019:
Net Cash Provided by/Used for Operating Activities:
Net cash provided by operating activities was $4.9 billion for the year ended December 26, 2020 compared to $3.6 billion for the year ended December 28, 2019. This increase was primarily driven by higher Adjusted EBITDA and favorable changes in accounts payable and other current liabilities, largely due to the timing of payments.
Net Cash Provided by/Used for Investing Activities:
Net cash used for investing activities was $522 million for the year ended December 26, 2020 compared to net cash provided by investing activities of $1.5 billion for the year ended December 28, 2019. This change was primarily driven by proceeds from our Canada Natural Cheese Transaction and Heinz India Transaction received in 2019 and lower proceeds from our net investment hedges in 2020 compared to 2019, partially offset by cash paid to acquire Primal Nutrition, LLC in 2019 and lower capital expenditures in 2020 compared to 2019. We expect 2021 capital expenditures to be approximately $900 million. However, given the COVID-19 pandemic, our estimates of capital expenditures are subject to change. See Note 4, Acquisitions and Divestitures, in Item 8, Financial Statements and Supplementary Data, for additional information on the Canada Natural Cheese Transaction, Heinz India Transaction, and the acquisition of Primal Nutrition, LLC.
Net Cash Provided by/Used for Financing Activities:
Net cash used for financing activities was $3.3 billion for the year ended December 26, 2020 compared to $3.9 billion for the year ended December 28, 2019. This decrease was primarily driven by higher proceeds received from long-term debt issuances and lower repayments of long-term debt in 2020 compared to 2019. See Note 18, Debt, in Item 8, Financial Statements and Supplementary Data, for additional information on our long-term debt issuances and debt repayments.
Cash Held by International Subsidiaries:
Of the $3.4 billion cash and cash equivalents on our consolidated balance sheet at December 26, 2020, $910 million was held by international subsidiaries.
Subsequent to January 1, 2018, we consider the unremitted earnings of certain international subsidiaries that impose local country taxes on dividends to be indefinitely reinvested. For those undistributed earnings considered to be indefinitely reinvested, our intent is to reinvest these funds in our international operations, and our current plans do not demonstrate a need to repatriate the accumulated earnings to fund our U.S. cash requirements. The amount of unrecognized deferred tax liabilities
for local country withholding taxes that would be owed related to our 2018, 2019, and 2020 accumulated earnings of certain international subsidiaries is approximately $20 million.
Our undistributed historic earnings in foreign subsidiaries through December 30, 2017 are currently not considered to be indefinitely reinvested. As of December 26, 2020 and December 28, 2019, we had recorded a deferred tax liability of approximately $20 million on approximately $300 million of historic earnings related to local withholding taxes that will be owed when this cash is distributed.
Trade Payables Programs:
In order to manage our cash flow and related liquidity, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with our suppliers, which we deem to be commercially reasonable, generally range from 0 to 200 days. We also maintain agreements with third party administrators that allow participating suppliers to track payment obligations from us, and, at the sole discretion of the supplier, sell one or more of those payment obligations to participating financial institutions. We have no economic interest in a supplier’s decision to enter into these agreements and no direct financial relationship with the financial institutions. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. Supplier participation in these agreements is voluntary. We estimate that the amounts outstanding under these programs were $740 million at December 26, 2020 and $370 million at December 28, 2019.
Borrowing Arrangements:
We have historically obtained funding through our U.S. and European commercial paper programs. We had no commercial paper outstanding at December 26, 2020, at December 28, 2019, or during the year ended December 26, 2020. The maximum amount of commercial paper outstanding during the year ended December 28, 2019 was $200 million.
We maintain our Senior Credit Facility, which, following the execution of the Commitment Increase Amendment on October 9, 2020, provides aggregate commitments of $4.1 billion through July 6, 2023 and $4.0 billion through July 6, 2024. 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 $900 million. $4.0 billion was drawn on our Senior Credit Facility during the first quarter of 2020. We repaid the full $4.0 billion revolver draw during the second quarter of 2020. No amounts were drawn on our Senior Credit Facility at December 26, 2020, at December 28, 2019, or during the years ended December 28, 2019 and December 29, 2018.
The Senior Credit Facility contains representations, warranties, and covenants that are typical for these types of facilities and could upon the occurrence of certain events of default restrict our ability to access our Senior Credit Facility. We were in compliance with all financial covenants as of December 26, 2020.
Long-Term Debt:
Our long-term debt, including the current portion, was $28.3 billion at December 26, 2020 and $29.2 billion at December 28, 2019. This decrease was primarily related to the $2.1 billion aggregate principal amount of certain senior notes that were validly tendered in May 2020, the $1.3 billion aggregate principal amount of senior notes redeemed in June 2020, the $302 million aggregate principal amount of senior notes redeemed in October 2020, the $405 million aggregate principal amount of senior notes that were repaid at maturity in February 2020, and the $200 million aggregate principal amount of senior notes and 500 million Canadian dollars aggregate principal amount of senior notes that we repaid at maturity in July 2020. These decreases to long-term debt were partially offset by the $3.5 billion aggregate principal amount of senior notes issued in May 2020. We used the proceeds from the issuance of these senior notes to fund our tender offers in May 2020 and to pay fees and expenses in connection therewith, and to fund our debt redemptions in June 2020. We used cash on hand to fund our debt redemption in October 2020.
As a result of the senior notes issued in May 2020 and the settlement of our tender offers in May 2020 and our debt redemptions in June 2020, we extinguished aggregate principal amounts of senior notes of approximately $539 million that were due to mature in February 2021 and approximately $300 million that were due to mature in June 2021.
We repaid approximately $111 million aggregate principal amount of senior notes on February 10, 2021. We have aggregate principal amount of senior notes of approximately $34 million maturing in September 2021. We expect to fund these long-term debt repayments primarily with cash on hand and cash generated from our operating activities.
In September 2020, we entered into the Cheese Transaction for total consideration of approximately $3.3 billion, including approximately $3.2 billion of cash consideration. The Cheese Transaction is expected to close in the first half of 2021, subject to customary closing conditions, including regulatory approvals. We expect to use post-tax transaction proceeds primarily to repay long-term debt. See Note 4, Acquisitions and Divestitures, in Item 8, Financial Statements and Supplementary Data, for additional information on the Cheese Transaction.
Our long-term debt contains customary representations, covenants, and events of default. We were in compliance with all financial covenants as of December 26, 2020.
See Note 18, Debt, in Item 8, Financial Statements and Supplementary Data, for additional information related to our long-term debt.
Supplemental Guarantor Information:
In March 2020, the SEC amended Rule 3-10 of Regulation S-X regarding financial disclosure requirements for certain debt securities, with an effective date of January 4, 2021. We chose to voluntarily adopt the amended rules effective for the quarterly period ended June 27, 2020 and for all periods thereafter.
The Kraft Heinz Company (as the “Parent Guarantor”) fully and unconditionally guarantees all the senior unsecured registered notes (collectively, the “KHFC Senior Notes”) issued by Kraft Heinz Foods Company (“KHFC”), our 100% owned operating subsidiary (the “Guarantee”). See Note 18, Debt, in Item 8, Financial Statements and Supplementary Data, for additional descriptions of these guarantees.
The payment of the principal, premium, and interest on the KHFC Senior Notes is fully and unconditionally guaranteed on a senior unsecured basis by the Parent Guarantor, pursuant to the terms and conditions of the applicable indenture. None of the Parent Guarantor’s subsidiaries guarantee the KHFC Senior Notes.
The Guarantee is the Parent Guarantor’s senior unsecured obligation and is: (i) pari passu in right of payment with all of the Parent Guarantor’s existing and future senior indebtedness; (ii) senior in right of payment to all of the Parent Guarantor’s future subordinated indebtedness; (iii) effectively subordinated to all of the Parent Guarantor’s existing and future secured indebtedness to the extent of the value of the assets secured by that indebtedness; and (iv) effectively subordinated to all existing and future indebtedness and other liabilities of the Parent Guarantor’s subsidiaries.
The KHFC Senior Notes are obligations exclusively of KHFC and the Parent Guarantor and not of any of the Parent Guarantor’s other subsidiaries. Substantially all of the Parent Guarantor’s operations are conducted through its subsidiaries. The Parent Guarantor’s other subsidiaries are separate legal entities that have no obligation to pay any amounts due under the KHFC Senior Notes or to make any funds available therefor, whether by dividends, loans, or other payments. Except to the extent the Parent Guarantor is a creditor with recognized claims against its subsidiaries, all claims of creditors (including trade creditors) and holders of preferred stock, if any, of its subsidiaries will have priority with respect to the assets of such subsidiaries over its claims (and therefore the claims of its creditors, including holders of the KHFC Senior Notes). Consequently, the KHFC Senior Notes are structurally subordinated to all liabilities of the Parent Guarantor’s subsidiaries and any subsidiaries that it may in the future acquire or establish. The obligations of the Parent Guarantor will terminate and be of no further force or effect in the following circumstances: (i) (a) KHFC’s exercise of its legal defeasance option or, except in the case of a guarantee of any direct or indirect parent of KHFC, covenant defeasance option in accordance with the applicable indenture, or KHFC’s obligations under the applicable indenture have been discharged in accordance with the terms of the applicable indenture or (b) as specified in a supplemental indenture to the applicable indenture; and (ii) the Parent Guarantor has delivered to the trustee an officer’s certificate and an opinion of counsel, each stating that all conditions precedent provided for in the applicable indenture have been complied with. The Guarantee is limited by its terms to an amount not to exceed the maximum amount that can be guaranteed by the Parent Guarantor without rendering the Guarantee voidable under applicable law relating to fraudulent conveyance or fraudulent transfer or similar laws affecting the rights of creditors generally.
The following tables present summarized financial information for the Parent Guarantor and KHFC (as subsidiary issuer of the KHFC Senior Notes) (together, the “Obligor Group”), on a combined basis after the elimination of all intercompany balances and transactions between the Parent Guarantor and subsidiary issuer and investments in any subsidiary that is a non-guarantor.
Summarized Statement of Income
| December 26, 2020 | |||||
| Net sales | $ | 18,119 | |||
| Gross profit(a) | 6,778 | ||||
| Goodwill impairment losses | 300 | ||||
| Intercompany service fees and other recharges | 4,297 | ||||
| Operating income/(loss) | 1,195 | ||||
| Equity in earnings/(losses) of subsidiaries | 477 | ||||
| Net income/(loss) | 356 | ||||
| Net income/(loss) attributable to common shareholders | 356 |
(a) In 2020, the Obligor Group recorded $427 million of net sales to the non-guarantor subsidiaries and $54 million of purchases from the non-guarantor subsidiaries.
Summarized Balance Sheets
| December 26, 2020 | |||||
| ASSETS | |||||
| Current assets | $ | 6,978 | |||
| Current assets due from affiliates(a) | 3,233 | ||||
| Non-current assets | 5,562 | ||||
| Goodwill | 10,510 | ||||
| Intangible assets, net | 2,475 | ||||
| Non-current assets due from affiliates(b) | 207 | ||||
| LIABILITIES | |||||
| Current liabilities | $ | 4,611 | |||
| Current liabilities due to affiliates(a) | 5,160 | ||||
| Non-current liabilities | 30,251 | ||||
| Non-current liabilities due to affiliates(b) | 2,000 |
(a) Represents receivables and short-term lending due from and payables and short-term lending due to non-guarantor subsidiaries.
(b) Represents long-term lending due from and long-term borrowings due to non-guarantor subsidiaries.
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.
Aggregate Contractual Obligations:
The following table summarizes our contractual obligations at December 26, 2020 (in millions):
| Payments Due | |||||||||||||||||||||||||||||
| 2021 | 2022-2023 | 2024-2025 | 2026 and Thereafter | Total | |||||||||||||||||||||||||
| Long-term debt(a) | $ | 1,364 | $ | 4,695 | $ | 4,571 | $ | 36,912 | $ | 47,542 | |||||||||||||||||||
| Finance leases(b) | 86 | 51 | 24 | 86 | 247 | ||||||||||||||||||||||||
| Operating leases(c) | 157 | 213 | 142 | 284 | 796 | ||||||||||||||||||||||||
| Purchase obligations(d) | 579 | 761 | 350 | 124 | 1,814 | ||||||||||||||||||||||||
| Other long-term liabilities(e) | 36 | 95 | 147 | 182 | 460 | ||||||||||||||||||||||||
| Total | $ | 2,222 | $ | 5,815 | $ | 5,234 | $ | 37,588 | $ | 50,859 |
(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 26, 2020.
(b) Amounts represent the expected cash payments of our finance leases, including expected cash payments of interest expense.
(c) Operating leases represent the minimum rental commitments under non-cancellable operating leases net of sublease income.
(d) We have purchase obligations for materials, supplies, property, plant and equipment, and co-packing, storage, and distribution services based on projected needs to be utilized in the normal course of business. Other purchase obligations include commitments for marketing, advertising, capital expenditures, information technology, and professional services. Arrangements are considered purchase obligations if a contract specifies all significant terms, including fixed or minimum quantities to be purchased, a pricing structure, and approximate timing of the transaction. Several of these obligations are long-term and are based on minimum purchase requirements. Certain purchase obligations contain variable pricing components, and, as a result, actual cash payments are expected to fluctuate based on changes in these variable components. Due to the proprietary nature of some of our materials and processes, certain supply contracts contain penalty provisions for early terminations. We do not believe that a material amount of penalties is reasonably likely to be incurred under these contracts based upon historical experience and current expectations. We exclude amounts reflected on the consolidated balance sheet as accounts payable and accrued liabilities from the table above.
(e) Other long-term liabilities primarily consist of estimated payments for the one-time toll charge related to U.S. Tax Reform, as well as postretirement benefit commitments. Certain other long-term liabilities related to income taxes, insurance accruals, and other accruals included on the consolidated balance sheet are excluded from the above table as we are unable to estimate the timing of payments for these items.
Pension plan contributions were $15 million in 2020. We estimate that 2021 pension plan contributions will be approximately $14 million. Estimated future contributions take into consideration current economic conditions, including the impacts of COVID-19, which at this time are expected to have minimal impact on expected contributions for 2021. Beyond 2021, we are unable to reliably estimate the timing of contributions to our pension plans. Our actual contributions and plans may change due to many factors, including changes in tax, employee benefit, or other laws and regulations, tax deductibility, significant differences between expected and actual pension asset performance or interest rates, or other factors. As such, estimated pension plan contributions for 2021 have been excluded from the above table.
Postretirement benefit plan contributions were $12 million in 2020. We estimate that 2021 postretirement benefit plan contributions will be approximately $14 million. Estimated future contributions take into consideration current economic conditions, including the impacts of COVID-19, which at this time are expected to have minimal impact on expected contributions for 2021. Beyond 2021, 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 2021 have been excluded from the above table.
At December 26, 2020, 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 $491 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
We paid common stock dividends of $2.0 billion in both 2020 and 2019 and $3.2 billion in 2018. Additionally, on February 11, 2021, our Board declared a cash dividend of $0.40 per share of common stock, which is payable on March 26, 2021 to shareholders of record on March 12, 2021.
The declaration of dividends is subject to the discretion of our Board and depends on various factors, including our net income, financial condition, cash requirements, future prospects, and other factors that our Board deems relevant to its analysis and decision making.
Non-GAAP Financial Measures
The non-GAAP financial measures we provide in this report should be viewed in addition to, and not as an alternative for, results prepared in accordance with U.S. GAAP.
To supplement the consolidated financial statements prepared in accordance with U.S. GAAP, we have presented Organic Net Sales, Adjusted EBITDA, and Adjusted EPS, which are considered non-GAAP financial measures. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. These measures are not substitutes for their comparable U.S. GAAP financial measures, such as net sales, net income/(loss), diluted earnings per share (“EPS”), or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures.
Management uses these non-GAAP financial measures to assist in comparing our performance on a consistent basis for purposes of business decision making by removing the impact of certain items that management believes do not directly reflect our underlying operations. Management believes that presenting our non-GAAP financial measures (i.e., Organic Net Sales, Adjusted EBITDA, and Adjusted EPS) is useful to investors because it (i) provides investors with meaningful supplemental information regarding financial performance by excluding certain items, (ii) permits investors to view performance using the same tools that management uses to budget, make operating and strategic decisions, and evaluate historical performance, and (iii) otherwise provides supplemental information that may be useful to investors in evaluating our results. We believe that the presentation of these non-GAAP financial measures, when considered together with the corresponding U.S. GAAP financial measures and the reconciliations to those measures, provides investors with additional understanding of the factors and trends affecting our business than could be obtained absent these disclosures.
Organic Net Sales is defined as net sales excluding, when they occur, the impact of currency, acquisitions and divestitures, and a 53rd week of shipments. We calculate the impact of currency on net sales by holding exchange rates constant at the previous year’s exchange rate, with the exception of highly inflationary subsidiaries, for which we calculate the previous year’s results using the current year’s exchange rate. Organic Net Sales is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Adjusted EBITDA is defined as net income/(loss) from continuing operations before interest expense, other expense/(income), provision for/(benefit from) income taxes, and depreciation and amortization (excluding integration and restructuring expenses); in addition to these adjustments, we exclude, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized losses/(gains) on commodity hedges, impairment losses, and equity award compensation expense (excluding integration and restructuring expenses). Adjusted EBITDA is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.
Adjusted EPS is defined as diluted EPS excluding, when they occur, the impacts of integration and restructuring expenses, deal costs, unrealized losses/(gains) on commodity hedges, impairment losses, losses/(gains) on the sale of a business, other losses/(gains) related to acquisitions and divestitures (e.g., tax and hedging impacts), nonmonetary currency devaluation (e.g., remeasurement gains and losses), debt prepayment and extinguishment costs, and U.S. Tax Reform discrete income tax expense/(benefit), and including, when they occur, adjustments to reflect preferred stock dividend payments on an accrual basis. We believe Adjusted EPS provides important comparability of underlying operating results, allowing investors and management to assess operating performance on a consistent basis.
The Kraft Heinz Company
Reconciliation of Net Sales to Organic Net Sales
(dollars in millions)
(Unaudited)
| Net Sales | Currency | Acquisitions and Divestitures | Organic Net Sales | Price | Volume/Mix | ||||||||||||||||||||||||||||||
| 2020 | |||||||||||||||||||||||||||||||||||
| United States | $ | 19,204 | $ | — | $ | — | $ | 19,204 | |||||||||||||||||||||||||||
| International | 5,341 | (114) | — | 5,455 | |||||||||||||||||||||||||||||||
| Canada | 1,640 | (21) | — | 1,661 | |||||||||||||||||||||||||||||||
| Kraft Heinz | $ | 26,185 | $ | (135) | $ | — | $ | 26,320 | |||||||||||||||||||||||||||
| 2019 | |||||||||||||||||||||||||||||||||||
| United States | $ | 17,844 | $ | — | $ | — | $ | 17,844 | |||||||||||||||||||||||||||
| International | 5,251 | 27 | 13 | 5,211 | |||||||||||||||||||||||||||||||
| Canada | 1,882 | — | 219 | 1,663 | |||||||||||||||||||||||||||||||
| Kraft Heinz | $ | 24,977 | $ | 27 | $ | 232 | $ | 24,718 |
| Year-over-year growth rates | |||||||||||||||||||||||||||||||||||
| United States | 7.6 | % | 0.0 pp | 0.0 pp | 7.6 | % | 3.5 pp | 4.1 pp | |||||||||||||||||||||||||||
| International | 1.7 | % | (2.7) pp | (0.3) pp | 4.7 | % | 2.1 pp | 2.6 pp | |||||||||||||||||||||||||||
| Canada | (12.8) | % | (1.1) pp | (11.6) pp | (0.1) | % | 2.2 pp | (2.3) pp | |||||||||||||||||||||||||||
| Kraft Heinz | 4.8 | % | (0.7) pp | (1.0) pp | 6.5 | % | 3.1 pp | 3.4 pp |
The Kraft Heinz Company
Reconciliation of Net Income/(Loss) to Adjusted EBITDA
(in millions)
(Unaudited)
| December 26, 2020 | December 28, 2019 | ||||||||||
| Net income/(loss) | $ | 361 | $ | 1,933 | |||||||
| Interest expense | 1,394 | 1,361 | |||||||||
| Other expense/(income) | (296) | (952) | |||||||||
| Provision for/(benefit from) income taxes | 669 | 728 | |||||||||
| Operating income/(loss) | 2,128 | 3,070 | |||||||||
| Depreciation and amortization (excluding integration and restructuring expenses) | 955 | 985 | |||||||||
| Integration and restructuring expenses | 15 | 102 | |||||||||
| Deal costs | 8 | 19 | |||||||||
| Unrealized losses/(gains) on commodity hedges | (6) | (57) | |||||||||
| Impairment losses | 3,413 | 1,899 | |||||||||
| Equity award compensation expense (excluding integration and restructuring expenses) | 156 | 46 | |||||||||
| Adjusted EBITDA | $ | 6,669 | $ | 6,064 |
The Kraft Heinz Company
Reconciliation of Diluted EPS to Adjusted EPS
(Unaudited)
| December 26, 2020 | December 28, 2019 | ||||||||||
| Diluted EPS | $ | 0.29 | $ | 1.58 | |||||||
| Integration and restructuring expenses(a) | — | 0.07 | |||||||||
| Deal costs(b) | — | 0.02 | |||||||||
| Unrealized losses/(gains) on commodity hedges(c) | — | (0.04) | |||||||||
| Impairment losses(d) | 2.59 | 1.38 | |||||||||
| Losses/(gains) on sale of business(e) | (0.01) | (0.23) | |||||||||
| Nonmonetary currency devaluation(f) | — | 0.01 | |||||||||
| Debt prepayment and extinguishment costs(g) | 0.08 | 0.06 | |||||||||
| U.S. Tax Reform discrete income tax expense/(benefit)(h) | (0.07) | — | |||||||||
| Adjusted EPS | $ | 2.88 | $ | 2.85 |
(a) Gross expenses/(income) included in integration and restructuring expenses were income of $2 million ($3 million after-tax) in 2020 and expenses of $108 million ($83 million after-tax) in 2019 and were recorded in the following income statement line items:
-
Cost of products sold included income of $20 million in 2020 and expenses of $48 million in 2019;
-
SG&A included expenses of $35 million in 2020 and $54 million in 2019; and
-
Other expense/(income) included income of $17 million in 2020 and expenses of $6 million in 2019.
(b) Gross expenses included in deal costs were $8 million ($6 million after-tax) in 2020 and $19 million ($18 million after-tax) in 2019 and were recorded in SG&A.
(c) Gross expenses/(income) included in unrealized losses/(gains) on commodity hedges were income of $6 million ($4 million after-tax) in 2020 and income of $57 million ($43 million after-tax) in 2019 and were recorded in cost of products sold.
(d) Gross impairment losses included the following:
-
Goodwill impairment losses of $2.3 billion ($2.3 billion after-tax) in 2020 and $1.2 billion ($1.2 billion after-tax) in 2019, which were recorded in SG&A;
-
Intangible asset impairment losses of $1.1 billion ($829 million after-tax) in 2020 and $702 million ($537 million after-tax) in 2019, which were recorded in SG&A; and
-
Property, plant and equipment asset impairment losses of $14 million ($1 million after-tax) in 2020, which were recorded in cost of products sold.
(e) Gross expenses/(income) included in losses/(gains) on sale of business were expenses of $2 million (income of $6 million after-tax) in 2020 and income of $420 million ($275 million after-tax) in 2019 and were recorded in other expense/(income).
(f) Gross expenses included in nonmonetary currency devaluation were $6 million ($6 million after-tax) in 2020 and $10 million ($10 million after-tax) in 2019 and were recorded in other expense/(income).
(g) Gross expenses included in debt prepayment and extinguishment costs were $124 million ($93 million after-tax) in 2020 and $98 million ($73 million after-tax) in 2019 and were recorded in interest expense.
(h) U.S. Tax Reform discrete income tax expense/(benefit) was a benefit of $81 million in 2020. The benefit in 2020 primarily relates to the revaluation of our deferred tax balances due to changes in state tax laws following U.S. Tax Reform and subsequent clarification or interpretation of state tax laws. See Note 10, Income Taxes, in Item 8, Financial Statements and Supplementary Data, for additional information.
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