Wednesday, February 24, 2021

Some firms disclose only a little about their goodwill testing and impairments; other firms disclose a lot.

And then, once in a blue moon, you get a disclosure like what Kraft Heinz Co. ($KHC) included in its annual filing on Feb. 17 — an opus nearly 4,000 words long, and a fascinating glimpse into how shifting corporate strategies translate into shifting numbers on the balance sheet.

First, let’s look at the headline numbers Kraft reported. As you can see in Figure 1, below, Kraft started 2020 with $35.55 billion in goodwill and ended it with $33.09 billion. That’s a drop of $2.46 billion, or 6.9 percent.

Those numbers, however, barely begin to tell what Kraft was doing last year. As always, you need to read the details in the footnotes!

First, Kraft reorganized both its internal operations and its reportable operations in early 2020. For example, it moved its Puerto Rico operations from its Latin America division to its U.S. division, and consolidated all its European operations into one, new International division. Ultimately Kraft landed on three reportable segments divided by geography: the United States, Canada, and International.

That’s important because a change so significant prompted Kraft to do two impairment tests of its goodwill assets — one immediately before the reorganization, the other immediately after. (Like, the two tests were performed on the same day, since the “reorg” was really just management moving items around from one P&L statement to another.)

The impairment test done after the reorganization resulted in two impairment charges totaling $226 million: one charge of $83 million for the Australia, New Zealand, and Japan unit; and another for $143 million in the Latin America unit. (Both units now included in one new International segment for reporting purposes.)

Impairment Tests, Part II

After those reorganization-related impairment tests at the beginning of 2020 came Kraft’s standard goodwill impairment test, which the company always conducts on the first day of its second quarter — March 29, 2020.

That test resulted in another impairment of $1.8 billion across four internal operating divisions:

  • $815 million charge in Kraft’s Canada Retail unit
  • $205 million charge in its Canada Foodservice unit
  • $655 million charge in its U.S. Foodservice unit
  • $142 million charge in its EMEA East reporting unit

Add those numbers together, plus the $226 million impairment charge from the reorganization test, and you get $2.043 billion — the amount reflected in Figure 1, above.

What drove those impairments, you ask? The company had this to say:

These impairments were primarily due to the completion of our enterprise strategy and five-year operating plan in the second quarter of 2020. Management, in completing the five-year operating plan, developed updated expectations regarding revenue growth and profitability opportunities associated with our reporting units and, as a result, has recalibrated our future investments to align with the opportunities for which we see greater potential for a return on those investments.

Translation: Kraft is tempering its expectations for future growth, as consumer tastes drift away from mass-produced food in a box toward fresh produce and more organic food. This isn’t news per se; recall that several years ago Kraft took an impairment charge of $15.4 billion in 2019. That impairment was an earlier, much larger example of shifting consumer trends hammering Kraft’s goodwill valuation.

But Wait, There’s More

Kraft then reorganized the operations within its U.S. reporting structure — “to align to the management of our new platforms, which were established to support the execution of our new enterprise strategy and five-year operating plan” — which meant the company had to perform a third impairment test, this time in June 2020.

That test didn’t result in any new impairment charges. But also that quarter, Kraft announced “the Cheese Transaction,” where the company agreed to sell its global cheese business to Groupe Lactalis for $3.3 billion. The Cheese Transaction was still pending at the time Kraft filed its 10-K (the deal should close sometime this spring), so to account for everything properly, Kraft had to shift $580 million from goodwill to assets held for sale. That number is also reflected in Figure 1, above.

We’re going to stop here because we have lives to lead, but analysts could delve into Kraft’s goodwill and impairment details all day long. Heck, right after the goodwill impairment analysis, Kraft launches into an equally long discussion of impairments to its intangible assets.

And don’t forget, you can also skim our Calcbench Research Guide for Goodwill & Intangible Assets. As Kraft demonstrates, there’s a lot of stuff to consider here.

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