What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing. Sometimes it seems like. In the past decade, america has seen more than its fair share of corporate mismanagement. That includes everything from the almost annual occurrences of major frauds and scandals uncovered on wall street to high profile cases like theranose, possibly the most disappointing.

Such cases are when everyday companies are implicated, your grocery store, your bank or even your favorite coffee shop might have been committing financial fraud, and you didn't even know it back. In 2015, toshiba announced that it was restating its profits going back several years. It turns out that they inappropriately recorded revenues from multi-million dollar contracts with customers to inflate profit numbers. Toshiba used to be one of the most recognizable brands of consumer electronics, dominating the markets for televisions and laptops, among other things.

But after the financial crisis of 2008 pressure to maintain the company's 100 year long legacy of profitability led leadership to recording revenues that hadn't actually happened yet and otherwise inflating quarterly results. The scandal ended in humiliation for the company and ceo who resigned in disgrace. Then there was also waste management which, after several decades of nothing but stunning, growth, eventually found it harder and harder to keep growing profitably by inexplicably fabricating depreciation timelines for their garbage trucks and other accounting gimmicks. They temporarily inflated reported profits until analysts uncovered the fraud.

In the end, it was uncovered that they overstayed profit by almost 2 billion dollars. We've made videos about both of those scandals, so check them out if you haven't already, but today is all about another seemingly benign company that also engage in accounting fraud on a massive scale. Craft heinz is one of the most ubiquitous consumer staples companies in the us. They own all sorts of brands that you'd be hard-pressed to miss at your local grocery store.

They include kraft, mac and cheese, heinz ketchup, grey, poupon, mustard, oscar meyer, hot dogs, philadelphia, cream cheese and many other brands. Their incredibly diversified portfolio of brands makes billions of dollars in revenue every single quarter, making them one of the 100 or so biggest corporations. In america. They even had the backing of the legendary investor warren buffett, but all of this success and their privileged position in the business world wasn't enough for two top-level executives at the company to perpetrate a massive accounting fraud worth millions of dollars.

In this video we'll go into detail about what they did and what drove them to it. In july of 2015, the two separate companies craft and heinz merged forming the kraft heinz company under the ticker symbol. Khc, one of the strongest drivers behind their merger was a promise of operational efficiencies and the elimination of redundancies across the two companies. Investors hoped to supercharge the net profits of the new company by reducing costs for a company like craft heinz, which sells in the consumer staples space and is already a dominant player.

It's often hard to continue growing sales for net profit to grow. Reducing costs is sometimes the only viable path forward. The newly merged craft heinz announced publicly that they had achieved much of these cost savings in their procurement division. Claus hoffman was a chief procurement officer during this time.

One of the methods that craft heinz employed to cut costs was to set performance targets for key employees in the procurement division. These performance targets were meant to push employees to negotiate more favorable contracts with the company's suppliers. Initially, this strategy worked and the target performance metrics were largely met. However, within a couple years, the low-hanging fruit had all been picked and employees found it more and more difficult to lower costs further.

Additionally, in 2017, foreign exchange rates and ingredient inflation started negatively, impacting procurement costs. The synergies touted by the merger of heinz and craft had already largely run out. Hoffman, meanwhile, was unwilling to accept anything less than perfection. He and other high up management continued imposing unrealistic expectations from their procurement division.

They demanded that employees constantly come up with new ideas to contribute to short-term cost savings. This helped build a high-pressure corporate environment that ended up incentivizing the wrong behavior as a result of the ambitious cost savings targets. Various craft heinz employees came up with a number of ways to artificially realize reductions in procurement costs. One method was so-called prebate transactions, whereby craft heinz employees agreed to sign on to long-term future contracts with suppliers in exchange for discounts up front according to generally accepted accounting principles.

Cost savings attached to future commitments cannot be recognized upfront. They have to be recognized on the official financial filings as the future commitments are fulfilled. Kraft heinz negotiated a number of these contracts and inappropriately recognized those cost savings up front. Another strategy was so-called clawback transactions.

With these transactions, krafthein's employees agreed to receive cash payments in the short term in return for paying increased prices in the long term. Despite the future commitments, kraft heinz reported the short term payments, as resulting from same year or past transactions with the suppliers. The final major strategy that kraft heinz devised was called price phasing transactions. These were similar to the clawback transactions, but instead of kraft heinz receiving payments up front in exchange for future price increases, they benefited from reduced prices from their suppliers for a short period.

These reduced prices were offset by agreeing to price increases in future periods. Again, these arrangements were reported to public shareholders in a deceptive manner, obscuring the future commitments that craft heinz had to make with all these strategies. The operational teams at kraft heinz did not accurately report the future commitments to the accounting teams. Essentially, they obscured the fact that they had in essence taking on additional liabilities for short-term savings when the finance groups reported krafthein's financial results and official filings.

These items were thus absent. Hoffman, the chief procurement officer, was at the center or directly enabled many of these unscrupulous strategies, for example, as early as 2015 in the same year as the merger, kraft heinz, was negotiating a deal with a supplier. The deal provided for a 3.5 million dollar payment to craft heinz in return for a three-year procurement contract that was favorable to the supplier. Later hoffman met with the ceo of that supplier to try to get them to reward the contract so that he could reasonably book the full 3.5 million dollar payment all up front.

He also discussed with other kraft heinz executives about the need to quote a line on wording unquote. Otherwise, he said the company would only be able to book, quote one-third of the benefit in the current year. Unquote. Eventually, the contract was reworded to describe the 3.5 million dollar payment as a non-refundable 2015 payment for purchases made in 2015..

Despite this word in clearly violating gaap hoffman approved of it and signed on to it in presentations to the board of the company, he did not provide details of the payment surrounding the future commitments. In the first few years, these schemes worked, hoffman was able to successfully maintain year-over-year cost savings, at least on paper. However, the future commitments of each deal made each successive year even more difficult by 2018 dozens of supplier contracts. With these future commitment arrangements had been made.

These commitments, along with unfavorable changes in foreign exchange rates and price inflation of inputs, college craft, heinz, reported cost of goods sold to deteriorate from right after the merger to around 2019 kraft heinz gross profit declined about twenty percent from two point: five billion dollars per quarter To two billion dollars you can explore this chart and other charts like it for us listed stocks at our new website wall streetmillennial.com before this deterioration occurred. However, kraft heinz capitalized on its inflated profit numbers by issuing debt. They also awarded hoffman lucrative stock and cash bonuses. As a result of successfully lowering costs for the company, but because all the cost savings were simply pulling forward future assets, the sham couldn't last forever in early 2019, kraft heinz announced that it would take a more than 10 billion loss for the previous year.

This was in part due to unfavorable developments and certain brands, the company owned. They also admitted to an sec probe into their accounting practices on the news, the stock tanked losing a third of its value. Since then, the stock has recovered slightly. In 2020, they announced new cost-cutting measures that they say will lead to two billion dollars of savings over several years.

This led to analyst upgrades of the stock and a rebound in the stock price. It remains to be seen if craft heinz can successfully implement real cost-saving measures that aren't just smoking mirrors. In september of 2020, the sec reached a settlement with kraft heinz over the accounting scandal. The company agreed to pay 62 million dollars in fines for the misconduct hoffman.

The chief procurement officer directly behind many of the sec's allegations got off with just a one hundred thousand dollar fine. Another executive involved at the company paid three hundred thousand dollars, but these penalties are in all likelihood only a small fraction of the total magnitude of their fraud. Alright, guys that wraps it up for this video. What do you think about craft heinz accounting standards? Do you think the management employees responsible for the scandal received fair punishment? Let us know, in the comments section below in the meantime, make sure to smash the like button and subscribe for future videos like this one.

As always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.