10-Q 1 form10-qq32017.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

Commission File Number 001-37482
kraftheinzlogo06.jpg
The Kraft Heinz Company
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)
 
46-2078182
(I.R.S. Employer Identification No.)
One PPG Place, Pittsburgh, Pennsylvania
(Address of Principal Executive Offices)
 
15222
(Zip Code)

Registrant’s telephone number, including area code: (412) 456-5700

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of October 28, 2017, there were 1,218,467,836 shares of the registrant’s common stock outstanding.



The Kraft Heinz Company
Table of Contents
Unless the context otherwise requires, the terms “we,” “us,” “our,” “Kraft Heinz,” and the “Company” each refer to The Kraft Heinz Company.



PART I - FINANCIAL INFORMATION
Item 1. Financial Statements and Supplementary Data.
The Kraft Heinz Company
Condensed Consolidated Statements of Income
(in millions, except per share data)
(Unaudited)
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
Net sales
$
6,314

 
$
6,267

 
$
19,355

 
$
19,630

Cost of products sold
4,000

 
4,049

 
12,059

 
12,503

Gross profit
2,314

 
2,218

 
7,296

 
7,127

Selling, general and administrative expenses
653

 
805

 
2,163

 
2,565

Operating income
1,661

 
1,413

 
5,133

 
4,562

Interest expense
306

 
311

 
926

 
824

Other expense/(income), net
(4
)
 
(3
)
 
8

 
(5
)
Income/(loss) before income taxes
1,359

 
1,105

 
4,199

 
3,743

Provision for/(benefit from) income taxes
416

 
262

 
1,205

 
1,045

Net income/(loss)
943

 
843

 
2,994

 
2,698

Net income/(loss) attributable to noncontrolling interest
(1
)
 
1

 
(2
)
 
10

Net income/(loss) attributable to Kraft Heinz
944

 
842

 
2,996

 
2,688

Preferred dividends

 

 

 
180

Net income/(loss) attributable to common shareholders
$
944

 
$
842

 
$
2,996

 
$
2,508

Per share data applicable to common shareholders:
 
 
 
 
 
 
 
Basic earnings/(loss)
$
0.78

 
$
0.69

 
$
2.46

 
$
2.06

Diluted earnings/(loss)
0.77

 
0.69

 
2.44

 
2.05

Dividends declared
0.625

 
0.60

 
1.825

 
1.75


See accompanying notes to the condensed consolidated financial statements.


1


The Kraft Heinz Company
Condensed Consolidated Statements of Comprehensive Income
(in millions)
(Unaudited)
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
Net income/(loss)
$
943

 
$
843

 
$
2,994

 
$
2,698

Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
421

 
(148
)
 
1,179

 
(294
)
Net deferred gains/(losses) on net investment hedges
(124
)
 
34

 
(327
)
 
79

Net actuarial gains/(losses) arising during the period
(4
)
 
(251
)
 
(13
)
 
(251
)
Prior service credits/(costs) arising during the period

 
106

 
1

 
106

Reclassification of net postemployment benefit losses/(gains)
(51
)
 
(39
)
 
(260
)
 
(143
)
Net deferred gains/(losses) on cash flow hedges
(70
)
 
31

 
(136
)
 
(1
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income
51

 
(26
)
 
97

 
(44
)
Total other comprehensive income/(loss)
223

 
(293
)
 
541

 
(548
)
Total comprehensive income/(loss)
1,166

 
550

 
3,535

 
2,150

Comprehensive income/(loss) attributable to noncontrolling interest
(1
)
 
3

 
(4
)
 
19

Comprehensive income/(loss) attributable to Kraft Heinz
$
1,167

 
$
547

 
$
3,539

 
$
2,131


See accompanying notes to the condensed consolidated financial statements.

2


The Kraft Heinz Company
Condensed Consolidated Balance Sheets
(in millions, except per share data)
(Unaudited)
 
September 30, 2017
 
December 31, 2016
ASSETS
 
 
 
Cash and cash equivalents
$
1,441

 
$
4,204

Trade receivables (net of allowances of $29 at September 30, 2017 and $20 at December 31, 2016)
938

 
769

Sold receivables
427

 
129

Inventories
3,188

 
2,684

Other current assets
1,234

 
967

Total current assets
7,228

 
8,753

Property, plant and equipment, net
6,934

 
6,688

Goodwill
44,858

 
44,125

Intangible assets, net
59,500

 
59,297

Other assets
1,531

 
1,617

TOTAL ASSETS
$
120,051

 
$
120,480

LIABILITIES AND EQUITY
 
 
 
Commercial paper and other short-term debt
$
455

 
$
645

Current portion of long-term debt
2,755

 
2,046

Trade payables
3,947

 
3,996

Accrued marketing
493

 
749

Accrued postemployment costs
158

 
157

Income taxes payable
169

 
255

Interest payable
295

 
415

Other current liabilities
1,115

 
1,238

Total current liabilities
9,387

 
9,501

Long-term debt
28,299

 
29,713

Deferred income taxes
20,898

 
20,848

Accrued postemployment costs
1,808

 
2,038

Other liabilities
688

 
806

TOTAL LIABILITIES
61,080

 
62,906

Commitments and Contingencies (Note 13)

 

Equity:
 
 
 
Common stock, $0.01 par value (5,000 shares authorized; 1,221 shares issued and 1,218 shares outstanding at September 30, 2017; 1,219 shares issued and 1,217 shares outstanding at December 31, 2016)
12

 
12

Additional paid-in capital
58,695

 
58,593

Retained earnings/(deficit)
1,360

 
588

Accumulated other comprehensive income/(losses)
(1,085
)
 
(1,628
)
Treasury stock, at cost (3 shares at September 30, 2017 and 2 shares at December 31, 2016)
(223
)
 
(207
)
Total shareholders' equity
58,759

 
57,358

Noncontrolling interest
212

 
216

TOTAL EQUITY
58,971

 
57,574

TOTAL LIABILITIES AND EQUITY
$
120,051

 
$
120,480


See accompanying notes to the condensed consolidated financial statements.

3


The Kraft Heinz Company
Condensed Consolidated Statement of Equity
(in millions)
(Unaudited)
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings/(Deficit)
 
Accumulated Other Comprehensive Income/(Losses)
 
Treasury Stock
 
Noncontrolling Interest
 
Total Equity
Balance at December 31, 2016
$
12

 
$
58,593

 
$
588

 
$
(1,628
)
 
$
(207
)
 
$
216

 
$
57,574

Net income/(loss)

 

 
2,996

 

 

 
(2
)
 
2,994

Other comprehensive income/(loss)

 

 

 
543

 

 
(2
)
 
541

Dividends declared-common stock

 

 
(2,225
)
 

 

 

 
(2,225
)
Exercise of stock options, issuance of other stock awards, and other

 
102

 
1

 

 
(16
)
 

 
87

Balance at September 30, 2017
$
12

 
$
58,695

 
$
1,360

 
$
(1,085
)
 
$
(223
)
 
$
212

 
$
58,971


See accompanying notes to the condensed consolidated financial statements.

4


The Kraft Heinz Company
Condensed Consolidated Statements of Cash Flows
(in millions)
(Unaudited)
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income/(loss)
$
2,994

 
$
2,698

Adjustments to reconcile net income/(loss) to operating cash flows:
 
 
 

Depreciation and amortization
790

 
1,010

Amortization of postretirement benefit plans prior service costs/(credits)
(247
)
 
(217
)
Equity award compensation expense
36

 
38

Deferred income tax provision/(benefit)
492

 
(28
)
Pension contributions
(174
)
 
(332
)
Other items, net
(76
)
 
(122
)
Changes in current assets and liabilities:
 
 
 
Trade receivables
(2,061
)
 
(1,443
)
Inventories
(580
)
 
(481
)
Accounts payable
123

 
480

Other current assets
(137
)
 
(58
)
Other current liabilities
(1,144
)
 
(529
)
Net cash provided by/(used for) operating activities
16

 
1,016

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Cash receipts on sold receivables
1,633

 
1,850

Capital expenditures
(956
)
 
(836
)
Other investing activities, net
47

 
70

Net cash provided by/(used for) investing activities
724

 
1,084

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayments of long-term debt
(2,636
)
 
(74
)
Proceeds from issuance of long-term debt
1,496

 
6,981

Proceeds from issuance of commercial paper
5,495

 
4,296

Repayments of commercial paper
(5,709
)
 
(3,660
)
Dividends paid-Series A Preferred Stock

 
(180
)
Dividends paid-common stock
(2,161
)
 
(2,123
)
Redemption of Series A Preferred Stock

 
(8,320
)
Other financing activities, net
26

 
56

Net cash provided by/(used for) financing activities
(3,489
)
 
(3,024
)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
43

 
(17
)
Cash, cash equivalents, and restricted cash
 
 
 
Net increase/(decrease)
(2,706
)
 
(941
)
Balance at beginning of period
4,255

 
4,912

Balance at end of period
$
1,549

 
$
3,971


See accompanying notes to the condensed consolidated financial statements.

5


The Kraft Heinz Company
Condensed Consolidated Statements of Cash Flows
(in millions)
(Unaudited)
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
Non-cash investing activities:
 
 
 
Beneficial interest obtained in exchange for securitized trade receivables
$
1,936

 
$
1,519


See accompanying notes to the condensed consolidated financial statements.


6


The Kraft Heinz Company
Notes to Condensed Consolidated Financial Statements
Note 1. Background and Basis of Presentation
Basis of Presentation:
Our interim condensed consolidated financial statements are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted, in accordance with the rules of the Securities and Exchange Commission (the “SEC”). In management’s opinion, these interim financial statements include all adjustments (consisting only of normal recurring adjustments) and accruals necessary to fairly state our results for the periods presented.
The condensed consolidated balance sheet data at December 31, 2016 was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. You should read these statements in conjunction with our audited consolidated financial statements and related notes in our Annual Report on Form 10-K for the year ended December 31, 2016. The results for interim periods are not necessarily indicative of future or annual results.
Organization:
On July 2, 2015, through a series of transactions, we consummated the merger of Kraft Foods Group, Inc. (“Kraft”) with and into a wholly-owned subsidiary of H.J. Heinz Holding Corporation (“Heinz”) (the “2015 Merger”). At the closing of the 2015 Merger, Heinz was renamed The Kraft Heinz Company (“Kraft Heinz”). Before the consummation of the 2015 Merger, Heinz was controlled by Berkshire Hathaway Inc. and 3G Global Food Holdings, L.P. (“3G Capital”), following their acquisition of H. J. Heinz Company (the “2013 Merger”) on June 7, 2013.
Accounting Standards Adopted in the Current Year:
In March 2016, the Financial Accounting Standards Board (the “FASB”) issued accounting standards update (“ASU”) 2016-09 related to equity-based award accounting and presentation. Under this guidance, excess tax benefits upon the exercise of share- based payment awards are recognized in our tax provision rather than within equity. Cash flows related to excess tax benefits are classified as operating activities rather than financing activities. Additionally, cash flows related to employee tax withholdings on restricted share vesting are classified as financing activities. This ASU became effective in the first quarter of 2017. We adopted the guidance related to excess tax benefits on a prospective basis. As a result, we recognized a tax benefit in our condensed consolidated statement of income of $3 million for the three months and $19 million for the nine months ended September 30, 2017 related to our excess tax benefits upon the exercise of share-based payment awards. We retrospectively adopted the guidance related to cash flow classification of employee tax withholdings on restricted share vesting. This guidance did not have a material impact on our condensed consolidated statement of cash flows for the nine months ended October 2, 2016 or on our consolidated statement of cash flows for the year ended December 31, 2016. Our equity award compensation cost continues to reflect estimated forfeitures.
In August 2016, the FASB issued ASU 2016-15 related to the classification of certain cash payments and cash receipts on the statement of cash flows. This ASU provided guidance on eight specific cash flow classification matters, which must be adopted in the same period using a retrospective transition method. We early adopted this ASU in the first quarter of 2017. We now classify consideration received for beneficial interest obtained for transferring trade receivables in securitization transactions as investing activities instead of operating activities. Accordingly, we reclassified $1.9 billion of cash receipts from the payments on sold receivables (which are cash receipts on the underlying trade receivables that have already been securitized) to cash provided by investing activities (from cash provided by operating activities) for the nine months ended October 2, 2016. The related impact on our consolidated statement of cash flows for the year ended December 31, 2016 was $2.6 billion. In connection with the adoption of ASU 2016-15, we also corrected other immaterial cash flow misstatements within operating activities, which overstated the amount of beneficial interest obtained in the non-cash exchange from the securitization of trade receivables. Additionally, we now classify cash payments for debt prepayment and debt extinguishment costs as cash outflows from financing activities rather than cash outflows from operating activities, which had no impact our condensed consolidated statements of cash flows for the nine months ended October 2, 2016 or our consolidated statement of cash flows for the year ended December 31, 2016.

7


In November 2016, the FASB issued ASU 2016-18 requiring the statement of cash flows to explain the change in restricted cash and restricted cash equivalents, in addition to cash and cash equivalents. We early adopted this ASU in the first quarter of 2017. Accordingly, we restated our cash and cash equivalents balances in the condensed consolidated statements of cash flows to include restricted cash of $51 million at December 31, 2016, $51 million at October 2, 2016, and $75 million at January 3, 2016. Additionally, cash used for investing activities increased by $24 million for the nine months ended October 2, 2016 and increased by $24 million for the year ended December 31, 2016. As required by the ASU, we have provided a reconciliation from cash and cash equivalents as presented on our condensed consolidated balance sheets to cash, cash equivalents, and restricted cash as reported on our condensed consolidated statements of cash flows. See Note 3, Restricted Cash, for this reconciliation, as well as a discussion of the nature of our restricted cash balances.
Recently Issued Accounting Standards:
In May 2014, the FASB issued ASU 2014-09, which superseded previously existing revenue recognition guidance. Under this ASU, companies will apply a principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the company expects to be entitled to in exchange for those goods or services. This ASU will be effective beginning in the first quarter of our fiscal year 2018. The ASU may be applied using a full retrospective method or a modified retrospective transition method, with a cumulative-effect adjustment as of the date of adoption. We currently expect the impact of this guidance to be immaterial to our financial statements and related disclosures. We will adopt this ASU using the full retrospective method on the first day of our fiscal year 2018.
In February 2016, the FASB issued ASU 2016-02, which superseded previously existing leasing guidance. The ASU is intended to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The new guidance requires lessees to reflect most leases on their balance sheets as assets and obligations. This ASU will be effective beginning in the first quarter of our fiscal year 2019. Early adoption is permitted. The new guidance must be adopted using a modified retrospective transition, and provides for certain practical expedients. While we are still evaluating the impact this ASU will have on our financial statements and related disclosures, we have completed our scoping reviews and have made progress in our assessment phase. We have identified our significant leases by geography and by asset type as well as our leasing processes which will be impacted by the new standard. We have also made progress in developing the policy elections we will make upon adoption. We expect that our financial statement disclosures will be expanded to present additional details of our leasing arrangements. At this time, we are unable to reasonably estimate the expected increase in assets and liabilities on our condensed consolidated balance sheets upon adoption. We will adopt this ASU on the first day of our fiscal year 2019.
In October 2016, the FASB issued ASU 2016-16 related to the income tax accounting impacts of intra-entity transfers of assets other than inventory, such as intellectual property and property, plant and equipment. Under the new accounting guidance, current and deferred income taxes should be recognized upon transfer of the assets. Previously, recognition of current and deferred income taxes was prohibited until the asset was sold to an external party. This ASU will be effective beginning in the first quarter of our fiscal year 2018. Early adoption is permitted but must be adopted in the first interim period of the annual period for which the ASU is adopted. The new guidance must be adopted on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the adoption period. We will adopt this ASU on the first day of our fiscal year 2018. While we are still evaluating the impact of this ASU, we currently anticipate a cumulative effect adjustment to retained earnings of approximately $100 million upon adoption.
In January 2017, the FASB issued ASU 2017-04 related to goodwill impairment testing. This ASU eliminates Step 2 from the goodwill impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, the entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. Previously, if the fair value of a reporting unit was lower than its carrying amount (Step 1), an entity was required to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount (Step 2). Additionally, under the new standard, entities that have reporting units with zero or negative carrying amounts will no longer be required to perform the qualitative assessment to determine whether to perform Step 2 of the goodwill impairment test. As a result, reporting units with zero or negative carrying amounts will generally be expected to pass the simplified impairment test; however, additional disclosure will be required of those entities. This ASU will be effective beginning in the first quarter of our fiscal year 2020. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The new guidance must be adopted on a prospective basis. While we are still evaluating the timing of adoption, we currently do not expect this ASU to have a material impact on our financial statements and related disclosures.

8


In March 2017, the FASB issued ASU 2017-07 related to the presentation of net periodic benefit cost (pension and postretirement cost). This ASU will be effective beginning in the first quarter of our fiscal year 2018. Under the new guidance, the service cost component of net periodic benefit cost must be presented in the same statement of income line item as other employee compensation costs arising from services rendered by employees during the period. Other components of net periodic benefit cost must be disaggregated from the service cost component in the statements of income and must be presented outside the operating income subtotal. Additionally, only the service cost component will be eligible for capitalization in assets. The new guidance must be applied retrospectively for the statement of income presentation of service cost components and other net periodic benefit cost components and prospectively for the capitalization of service cost components. There is a practical expedient that allows us to use historical amounts disclosed in our Postemployment Benefits footnote as an estimation basis for retrospectively applying the statement of income presentation requirements. We plan to use this practical expedient when we adopt this ASU on the first day of our fiscal year 2018. The retrospective impact of adopting ASU 2017-07 in 2018 is expected to be (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
For the Year Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
 
December 31,
2016
Increase/(decrease) to cost of products sold
$
109

 
$
81

 
$
455

 
$
259

 
$
373

Increase/(decrease) to selling, general and administrative expenses
14

 
14

 
63

 
66

 
93

Increase/(decrease) to operating income(a)
(123
)
 
(95
)
 
(518
)
 
(325
)
 
(466
)
(a)
Includes amortization of prior service costs/(credits), curtailments, special/contractual termination benefits, and certain settlements. These components of net pension and postretirement cost/(benefit) totaled approximately $(80) million for the three months and $(400) million for the nine months ended September 30, 2017, approximately $(70) million for the three months and $(240) million for the nine months ended October 2, 2016, and approximately $(340) million for the year ended December 31, 2016.
In August 2017, the FASB issued ASU 2017-12 related to accounting for hedging activities. This guidance will impact the accounting for our financial (i.e., foreign exchange and interest rate) and non-financial (i.e., commodity) hedging activities. Key components of this ASU that could impact us are as follows:
Grants the ability to hedge the risk associated with the change in a contractually specified component of the purchase or sale of a non-financial item instead of the total contractual price, which could allow more commodity contracts to qualify for hedge accounting;
Requires us to defer the entire change in value of the derivative, including the effective and ineffective portion, into other comprehensive income until the hedged item impacts net income. When released, the deferred hedge gains and losses, including the ineffective portion, will be recognized in the same statement of income line affected by the hedged item;
Allows us to recognize changes in the fair value of excluded components in other comprehensive income (which will be amortized into net income over the life of the derivative) or in net income in the related period;
Changes hedge effectiveness testing, including timing and allowable methods of testing; and,
Requires additional tabular disclosures in the footnotes to the financial statements.
The method for adopting the revised standard is modified retrospective. This ASU will be effective beginning in the first quarter of our fiscal year 2019; however, early adoption is permitted, including in an interim period. We are currently evaluating the timing of adoption and the impact this ASU will have on our financial statements and related disclosures.
Note 2. Integration and Restructuring Expenses
As part of our restructuring activities, we incur expenses that qualify as exit and disposal costs under U.S. GAAP. These include severance and employee benefit costs and other exit costs. Severance and employee benefit costs primarily relate to cash severance, non-cash severance, including accelerated equity award compensation expense, and pension and other termination benefits. Other exit costs primarily relate to lease and contract terminations. We also incur expenses that are an integral component of, and directly attributable to, our restructuring activities, which do not qualify as exit and disposal costs under U.S. GAAP. These include asset-related costs and other implementation costs. Asset-related costs primarily relate to accelerated depreciation and asset impairment charges. Other implementation costs primarily relate to start-up costs of new facilities, professional fees, asset relocation costs, and costs to exit facilities.

9


Employee severance and other termination benefit packages are primarily determined based on established benefit arrangements, local statutory requirements, or historical benefit practices. We recognize the contractual component of these benefits when payment is probable and estimable; additional elements of severance and termination benefits associated with non-recurring benefits are recognized ratably over each employee’s required future service period. Charges for accelerated depreciation are recognized on long-lived assets that will be taken out of service before the end of their normal service, in which case depreciation estimates are revised to reflect the use of the asset over its shortened useful life. Asset impairments establish a new fair value basis for assets held for disposal or sale and those assets are written down to expected net realizable value if carrying value exceeds fair value. All other costs are recognized as incurred.
Integration Program:
Following the 2015 Merger, we announced a multi-year program (the “Integration Program”) designed to reduce costs, streamline and simplify our operating structure as well as optimize our production and supply chain network across our businesses in the United States and Canada segments. We expect to incur pre-tax costs of $2.1 billion related to the Integration Program. These pre-tax costs are comprised of the following categories:
Organization costs ($400 million) associated with our plans to streamline and simplify our operating structure, resulting in workforce reduction (primarily severance and employee benefit costs).
Footprint costs ($1.3 billion) associated with our plans to optimize our production and supply chain network, resulting in workforce reduction and facility closures and consolidations (primarily asset-related costs and severance and employee benefit costs).
Other costs ($400 million) incurred as a direct result of integration activities, including other exit costs (primarily lease and contract terminations) and other implementation costs (primarily professional services and other third-party fees).
We expect that approximately 60% of the Integration Program expenses will be reflected in cost of products sold and approximately 60% will be cash expenditures.
Overall, as part of the Integration Program, we expect to eliminate 5,150 positions, close net six factories, and consolidate our distribution network. At September 30, 2017, the total Integration Program liability related primarily to the elimination of general salaried and factory positions across the United States and Canada, 4,800 of whom have left the Company by September 30, 2017. Additionally, as of September 30, 2017, we have closed net six factories.
Related to the Integration Program, we incurred costs of $79 million for the three months and $157 million for the nine months ended September 30, 2017 and $222 million for the three months and $722 million for the nine months ended October 2, 2016. As of September 30, 2017, we have incurred approximately $1.9 billion of cumulative costs under the Integration Program, including $543 million of severance and employee benefit costs, $803 million of non-cash asset-related costs, $417 million of other implementation costs, and $110 million of other exit costs.
In the second quarter of 2017, we recognized a curtailment gain of $168 million, which was classified as Integration Program expenses. The curtailment was triggered by the number of cumulative headcount reductions after the closure of certain U.S. factories in the second quarter of 2017. The resulting gain is attributed to accelerating a portion of the previously deferred actuarial gains and prior service credits. An additional curtailment gain of $9 million was recognized during the third quarter of 2017 based on additional employee exits associated with these factory closures. See Note 8, Postemployment Benefits, and Note 9, Accumulated Other Comprehensive Income/(Losses), for the related curtailment gain.
Our liability balance for Integration Program costs that qualify as exit and disposal costs under U.S. GAAP (i.e., severance and employee benefit costs and other exit costs), was (in millions):
 
Severance and Employee Benefit Costs
 
Other Exit Costs(a)
 
Total
Balance at December 31, 2016
$
99

 
$
10

 
$
109

Charges/(credits)
(138
)
 
15

 
(123
)
Cash payments
(55
)
 
(3
)
 
(58
)
Non-cash utilization
138

 
(3
)
 
135

Balance at September 30, 2017
$
44

 
$
19

 
$
63

(a) Other exit costs primarily consist of lease and contract terminations.
We expect the liability for severance and employee benefit costs as of September 30, 2017 to be paid in 2017. The liability for other exit costs primarily relates to lease obligations associated with restructuring programs executed prior to the 2015 Merger. The cash impact of these obligations will continue for the duration of the lease terms, which expire between 2019 and 2026.

10


Restructuring Activities:
In addition to our Integration Program in North America, we have a small number of other restructuring programs globally, which are focused primarily on workforce reduction and factory closure and consolidation. Related to these programs, approximately 500 employees left the Company during the nine months ended September 30, 2017. These programs resulted in expenses of $16 million for the three months ended September 30, 2017, including $8 million of severance and employee benefit costs, $7 million of other implementation costs, and $1 million of other exit costs. Other restructuring program expenses for the nine months ended September 30, 2017 were $80 million, including $37 million of severance and employee benefit costs, $1 million of non-cash asset-related costs, $32 million of other implementation costs, and $10 million of other exit costs. Other restructuring program expenses totaled $15 million for the three months and $59 million for the nine months ended October 2, 2016.
Our liability balance for restructuring project costs that qualify as exit and disposal costs under U.S. GAAP (i.e., severance and employee benefit costs and other exit costs), was (in millions):
 
Severance and Employee Benefit Costs
 
Other Exit Costs(a)
 
Total
Balance at December 31, 2016
$
12

 
$
25

 
$
37

Charges/(credits)
37

 
10

 
47

Cash payments
(32
)
 
(6
)
 
(38
)
Non-cash utilization
(7
)
 

 
(7
)
Balance at September 30, 2017
$
10

 
$
29

 
$
39

(a) Other exit costs primarily consist of lease and contract terminations.
We expect the liability for severance and employee benefit costs as of September 30, 2017 to be paid in 2017. The liability for other exit costs primarily relates to lease obligations associated with restructuring programs executed prior to the 2015 Merger. The cash impact of these obligations will continue for the duration of the lease terms, which expire between 2017 and 2026.
Total Integration and Restructuring:
Total expenses related to the Integration Program and restructuring activities recorded in cost of products sold and selling, general and administrative expenses were (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
Severance and employee benefit costs - COGS
$
(22
)
 
$
14

 
$
(139
)
 
$
43

Severance and employee benefit costs - SG&A
(3
)
 
43

 
38

 
89

Asset-related costs - COGS
34

 
89

 
134

 
368

Asset-related costs - SG&A
8

 
9

 
21

 
35

Other costs - COGS
68

 
49

 
129

 
121

Other costs - SG&A
10

 
33

 
54

 
125

 
$
95

 
$
237

 
$
237

 
$
781

We do not include Integration Program and restructuring expenses within Segment Adjusted EBITDA (as defined in Note 15, Segment Reporting). The pre-tax impact of allocating such expenses to our segments would have been (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
United States
$
75

 
$
161

 
$
118

 
$
607

Canada
(3
)
 
16

 
21

 
43

Europe
6

 
5

 
45

 
33

Rest of World

 

 
11

 

General corporate expenses
17

 
55

 
42

 
98

 
$
95

 
$
237

 
$
237

 
$
781


11


Note 3. Restricted Cash
The following table provides a reconciliation of cash and cash equivalents, as reported on our condensed consolidated balance sheets, to cash, cash equivalents, and restricted cash, as reported on our condensed consolidated statements of cash flows (in millions):
 
September 30, 2017
 
December 31, 2016
Cash and cash equivalents
$
1,441

 
$
4,204

Restricted cash included in other assets (current)
108

 
42

Restricted cash included in other assets (noncurrent)

 
9

Cash, cash equivalents, and restricted cash
$
1,549

 
$
4,255

Our restricted cash primarily relates to withholding taxes on our common stock dividends to our only significant international shareholder, 3G Capital.
Note 4. Inventories
Inventories consisted of the following (in millions):
 
September 30, 2017
 
December 31, 2016
Packaging and ingredients
$
713

 
$
542

Work in process
464

 
388

Finished product
2,011

 
1,754

Inventories
$
3,188

 
$
2,684

The increase in inventories for the nine months ended September 30, 2017 was primarily due to seasonality in the U.S.
Note 5. Goodwill and Intangible Assets
Goodwill:
Changes in the carrying amount of goodwill, by segment, were (in millions):
 
United States
 
Canada
 
Europe
 
Rest of World
 
Total
Balance at December 31, 2016
$
33,696

 
$
4,913

 
$
2,778

 
$
2,738

 
$
44,125

Translation adjustments and other

 
379

 
250

 
104

 
733

Balance at September 30, 2017
$
33,696

 
$
5,292

 
$
3,028

 
$
2,842

 
$
44,858

We test goodwill for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2017 annual impairment test as of April 2, 2017. As a result of our 2017 annual impairment test, there was no impairment of goodwill. Each of our goodwill reporting units had excess fair value over its carrying value of at least 10% as of April 2, 2017.
Our goodwill balance consists of 18 reporting units and had an aggregate carrying value of $44.9 billion as of September 30, 2017. As a majority of our goodwill was recently recorded in connection with the 2013 Merger and the 2015 Merger, representing fair values as of those merger dates, there was not a significant excess of fair values over carrying values as of April 2, 2017. We have a risk of future impairment to the extent that individual reporting unit performance does not meet our projections. Additionally, if our current assumptions and estimates, including projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors, are not met, or if valuation factors outside of our control change unfavorably, the estimated fair value of our goodwill could be adversely affected, leading to a potential impairment in the future. No events occurred during the three months ended September 30, 2017 that indicated it was more likely than not that our goodwill was impaired. There were no accumulated impairment losses to goodwill as of September 30, 2017.

12


Indefinite-lived intangible assets:
Indefinite-lived intangible assets, which primarily consisted of trademarks, were (in millions):
Balance at December 31, 2016
$
53,307

Translation adjustments
380

Impairment losses on indefinite-lived intangible assets
(48
)
Balance at September 30, 2017
$
53,639

We test indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2017 annual impairment test as of April 2, 2017. As a result of our 2017 annual impairment test, we recognized a non-cash impairment loss of $48 million in selling, general and administrative expenses for the nine months ended September 30, 2017. This loss was due to continued declines in nutritional beverages in India. The loss was recorded in our Europe segment as the related trademark is owned by our Italian subsidiary. Each of our other brands had excess fair value over its carrying value of at least 10% as of April 2, 2017.
Our indefinite-lived intangible assets primarily consist of a large number of individual brands and had an aggregate carrying value of $53.6 billion as of September 30, 2017. As a majority of our indefinite-lived intangible assets were recently recorded in connection with the 2013 Merger and the 2015 Merger, representing fair values as of those merger dates, there was not a significant excess of fair values over carrying values as of April 2, 2017. We have a risk of future impairment to the extent individual brand performance does not meet our projections. Additionally, if our current assumptions and estimates, including projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors, are not met, or if valuation factors outside of our control change unfavorably, the estimated fair values of our indefinite-lived intangible assets could be adversely affected, leading to potential impairments in the future. No events occurred during the three months ended September 30, 2017 that indicated it was more likely than not that our indefinite-lived intangible assets were impaired.
Definite-lived intangible assets:
Definite-lived intangible assets were (in millions):
 
September 30, 2017
 
December 31, 2016
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
Trademarks
$
2,381

 
$
(256
)
 
$
2,125

 
$
2,337

 
$
(172
)
 
$
2,165

Customer-related assets
4,230

 
(502
)
 
3,728

 
4,184

 
(369
)
 
3,815

Other
14

 
(6
)
 
8

 
13

 
(3
)
 
10

 
$
6,625

 
$
(764
)
 
$
5,861

 
$
6,534

 
$
(544
)
 
$
5,990

Amortization expense for definite-lived intangible assets was $76 million for the three months and $220 million for the nine months ended September 30, 2017 and was $66 million for the three months and $198 million for the nine months ended October 2, 2016. Aside from amortization expense, the changes in definite-lived intangible assets from December 31, 2016 to September 30, 2017 reflect the impact of foreign currency. We estimate that amortization expense related to definite-lived intangible assets will be approximately $280 million for the next twelve months and approximately $270 million for each of the four years thereafter.
Note 6. Income Taxes
The provision for income taxes consists of provisions for federal, state, and foreign income taxes. We operate in an international environment; accordingly, the consolidated effective tax rate is a composite rate reflecting the earnings in various locations and the applicable tax rates. Additionally, our quarterly income tax provision is determined based on our estimated full year effective tax rate, adjusted for tax attributable to infrequent or unusual items, which are recognized on a discrete period basis in the income tax provision for the period in which they occur.
Our effective tax rate was 30.6% for the three months ended September 30, 2017 compared to 23.7% for the three months ended October 2, 2016. The increase in our effective tax rate was driven by the unfavorable impact of net discrete items for the current quarter, primarily related to the impact of state tax law changes, compared to the favorable impact of foreign tax law changes and deferred tax adjustments for the three months ended October 2, 2016.
Our effective tax rate was 28.7% for the nine months ended September 30, 2017 compared to 27.9% for the nine months ended October 2, 2016. The increase in our effective tax rate was mainly driven by the unfavorable impact of a higher percentage of U.S. income reflected in our estimated full year effective tax rate for 2017 compared to 2016.

13


Note 7. Employees’ Stock Incentive Plans
Our annual equity award grants and vesting occurred in the first quarter of 2017. Other off-cycle equity grants may occur throughout the year.
Stock Options:
Our stock option activity and related information was:
 
Number of Stock Options
 
Weighted Average Exercise Price
(per share)
Outstanding at December 31, 2016
20,560,140

 
$
37.39

Granted
1,572,848

 
89.01

Forfeited
(559,109
)
 
48.13

Exercised
(2,005,638
)
 
32.94

Outstanding at September 30, 2017
19,568,241

 
41.69

The aggregate intrinsic value of stock options exercised during the period was $115 million for the nine months ended September 30, 2017.
Restricted Stock Units:
Our restricted stock unit (“RSU”) activity and related information was:
 
Number of Units
 
Weighted Average Grant Date Fair Value
(per share)
Outstanding at December 31, 2016
806,744

 
$
71.95

Granted
1,678,110

 
85.03

Forfeited
(191,072
)
 
82.85

Vested
(136,272
)
 
72.96

Outstanding at September 30, 2017
2,157,510

 
81.10

The aggregate fair value of RSUs that vested during the period was $12 million for the nine months ended September 30, 2017.

14


Note 8. Postemployment Benefits
Pension Plans
Components of Net Pension Cost/(Benefit):
Net pension cost/(benefit) consisted of the following (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
U.S. Plans
 
Non-U.S. Plans
 
U.S. Plans
 
Non-U.S. Plans
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
Service cost
$
3

 
$
3

 
$
5

 
$
6

 
$
8

 
$
10

 
$
13

 
$
18

Interest cost
45

 
52

 
17

 
21

 
136

 
158

 
49

 
64

Expected return on plan assets
(66
)
 
(73
)
 
(47
)
 
(44
)
 
(197
)
 
(221
)
 
(133
)
 
(137
)
Amortization of unrecognized losses/(gains)

 

 

 

 

 

 
1

 

Settlements
3

 
26

 

 

 
3

 
20

 

 

Special/contractual termination benefits
5

 

 

 

 
18

 

 
8

 

Other

 

 
(6
)
 

 
2

 

 
(15
)
 

Net pension cost/(benefit)
$
(10
)
 
$
8

 
$
(31
)
 
$
(17
)
 
$
(30
)
 
$
(33
)
 
$
(77
)
 
$
(55
)
We capitalized a portion of net pension cost/(benefit) into inventory based on our production activities. The amounts capitalized into inventory as of September 30, 2017 and October 2, 2016 are included in the table above.
Employer Contributions:
During the nine months ended September 30, 2017, we contributed $150 million to our U.S. pension plans and $24 million to our non-U.S. pension plans. Based on our contribution strategy, we plan to make further contributions of approximately $5 million to our non-U.S. plans during the remainder of 2017. We do not plan to make further contributions to our U.S. pension plans in 2017. Our actual contributions and plans may change due to many factors, including the timing of regulatory approval for the windup of certain non-U.S. pension plans, changes in tax, employee benefit, or other laws and regulations, tax deductibility, significant differences between expected and actual pension asset performance or interest rates, or other factors.
Postretirement Plans
Components of Net Postretirement Cost/(Benefit):
Net postretirement cost/(benefit) consisted of the following (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
Service cost
$
2

 
$
3

 
$
7

 
$
11

Interest cost
12

 
13

 
37

 
43

Amortization of prior service costs/(credits)
(77
)
 
(90
)
 
(250
)
 
(252
)
Curtailments
(9
)
 

 
(177
)
 

Net postretirement cost/(benefit)
$
(72
)
 
$
(74
)
 
$
(383
)
 
$
(198
)
We capitalized a portion of net postretirement cost/(benefit) into inventory based on our production activities. The amounts capitalized into inventory as of September 30, 2017 and October 2, 2016 are included in the table above.
In the second quarter of 2017, we remeasured certain of our postretirement plans and recognized a curtailment gain of $168 million. The curtailment was triggered by the number of cumulative headcount reductions after the closure of certain U.S. factories in the second quarter of 2017. The resulting gain is attributed to accelerating a portion of the previously deferred actuarial gains and prior service credits. An additional curtailment gain of $9 million was recognized during the third quarter of 2017 based on additional employee exits associated with these factory closures. The headcount reductions and factory closures were part of our ongoing Integration Program. See Note 2, Integration and Restructuring Expenses, for additional information.

15


Note 9. Accumulated Other Comprehensive Income/(Losses)
The components of, and changes in, accumulated other comprehensive income/(losses), net of tax, were as follows (in millions):
 
Foreign Currency Translation Adjustments
 
Net Postemployment Benefit Plan Adjustments
 
Net Cash Flow Hedge Adjustments
 
Total
Balance as of December 31, 2016
$
(2,412
)
 
$
772

 
$
12

 
$
(1,628
)
Foreign currency translation adjustments
1,181

 

 

 
1,181

Net deferred gains/(losses) on net investment hedges
(327
)
 

 

 
(327
)
Net postemployment benefit gains/(losses) arising during the period

 
(12
)
 

 
(12
)
Reclassification of net postemployment benefit losses/(gains)

 
(260
)
 

 
(260
)
Net deferred gains/(losses) on cash flow hedges

 

 
(136
)
 
(136
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income

 

 
97

 
97

Total other comprehensive income/(loss)
854

 
(272
)
 
(39
)
 
543

Balance as of September 30, 2017
$
(1,558
)
 
$
500

 
$
(27
)
 
$
(1,085
)
Reclassification of net postemployment benefit losses/(gains) included amounts reclassified to net income and amounts reclassified into inventory (consistent with our capitalization policy).
The gross amount and related tax benefit/(expense) recorded in, and associated with, each component of other comprehensive income/(loss) were as follows (in millions):
 
For the Three Months Ended
 
September 30,
2017
 
October 2,
2016
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
Foreign currency translation adjustments
$
421

 
$

 
$
421

 
$
(151
)
 
$

 
$
(151
)
Net deferred gains/(losses) on net investment hedges
(200
)
 
76

 
(124
)
 
34

 

 
34

Net actuarial gains/(losses) arising during the period
(1
)
 
(3
)
 
(4
)
 
(405
)
 
154

 
(251
)
Prior service credits/(costs) arising during the period

 

 

 
172

 
(66
)
 
106

Reclassification of net postemployment benefit losses/(gains)
(83
)
 
32

 
(51
)
 
(64
)
 
25

 
(39
)
Net deferred gains/(losses) on cash flow hedges
(76
)
 
6

 
(70
)
 
33

 
(2
)
 
31

Net deferred losses/(gains) on cash flow hedges reclassified to net income
51

 

 
51

 
(23
)
 
(3
)
 
(26
)
 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
Foreign currency translation adjustments
$
1,181

 
$

 
$
1,181

 
$
(304
)
 
$

 
$
(304
)
Net deferred gains/(losses) on net investment hedges
(568
)
 
241

 
(327
)
 
144

 
(65
)
 
79

Net actuarial gains/(losses) arising during the period
(11
)
 
(2
)
 
(13
)
 
(405
)
 
154

 
(251
)
Prior service credits/(costs) arising during the period
2

 
(1
)
 
1

 
172

 
(66
)
 
106

Reclassification of net postemployment benefit losses/(gains)
(423
)
 
163

 
(260
)
 
(232
)
 
89

 
(143
)
Net deferred gains/(losses) on cash flow hedges
(147
)
 
11

 
(136
)
 
(12
)
 
11

 
(1
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income
96

 
1

 
97

 
(43
)
 
(1
)
 
(44
)

16


The amounts reclassified from accumulated other comprehensive income/(losses) were as follows (in millions):
Accumulated Other Comprehensive Income/(Losses) Component
 
 Reclassified from Accumulated Other Comprehensive Income/(Losses)
 
Affected Line Item in the Statement Where Net Income/(Loss) is Presented
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
 
 
September 30,
2017
 
October 2,
2016
 
September 30,
2017
 
October 2,
2016
 
 
Losses/(gains) on cash flow hedges:
 
 
 
 

 
 
 
 

     Foreign exchange contracts
 
$

 
$


$

 
$
(3
)
 
Net sales
     Foreign exchange contracts
 
(2
)
 
(1
)

(5
)
 
(34
)
 
Cost of products sold
     Foreign exchange contracts
 
52

 
(23
)
 
98

 
(9
)
 
Other expense/(income), net
     Interest rate contracts
 
1

 
1


3

 
3

 
Interest expense
Losses/(gains) on cash flow hedges before income taxes
 
51

 
(23
)

96

 
(43
)
 
 
Losses/(gains) on cash flow hedges, income taxes
 

 
(3
)

1

 
(1
)
 
 
Losses/(gains) on cash flow hedges
 
$
51

 
$
(26
)

$
97

 
$
(44
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses/(gains) on postemployment benefits:
 
 
 
 

 
 
 
 

Amortization of unrecognized losses/(gains)
 
$

 
$

 
$
1

 
$

 
(a)
Amortization of prior service costs/(credits)
 
(77
)
 
(90
)

(250
)
 
(252
)
 
(a)
Settlement and curtailments losses/(gains)
 
(6
)
 
26


(174
)
 
20

 
(a)
Losses/(gains) on postemployment benefits before income taxes
 
(83
)
 
(64
)

(423
)
 
(232
)
 
 
Losses/(gains) on postemployment benefits, income taxes
 
32

 
25


163

 
89

 
 
Losses/(gains) on postemployment benefits
 
$
(51
)
 
$
(39
)

$
(260
)
 
$
(143
)
 
 
(a)
These components are included in the computation of net periodic postemployment benefit costs. See Note 8, Postemployment Benefits, for additional information.
In this note we have excluded activity and balances related to noncontrolling interest (which was primarily comprised of foreign currency translation adjustments) due to its insignificance.
Note 10. Financial Instruments
See our consolidated financial statements and related notes in our Annual Report on Form 10-K for the year ended December 31, 2016 for additional information on our overall risk management strategies, our use of derivatives, and our related accounting policies.
Derivative Volume:
The notional values of our derivative instruments were (in millions):
 
Notional Amount
 
September 30, 2017
 
December 31, 2016
Commodity contracts
$
332

 
$
459

Foreign exchange contracts
3,753

 
2,997

Cross-currency contracts
2,950

 
3,173


17


Fair Value of Derivative Instruments:
The fair values and the levels within the fair value hierarchy of derivative instruments recorded on the consolidated balance sheets were (in millions):
 
September 30, 2017
 
Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$

 
$
9

 
$
103

 
$

 
$

 
$
9

 
$
103

Cross-currency contracts

 

 
354

 

 

 

 
354

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
8

 
14

 

 
1

 

 

 
8

 
15

Foreign exchange contracts

 

 
46

 

 

 

 
46

 

Cross-currency contracts

 

 

 

 

 

 

 

Total fair value
$
8

 
$
14

 
$
409

 
$
104

 
$

 
$

 
$
417

 
$
118

 
December 31, 2016
 
Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$

 
$
69

 
$
13

 
$

 
$

 
$
69

 
$
13

Cross-currency contracts

 

 
580

 
36

 

 

 
580

 
36

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
28

 
7

 

 

 

 

 
28

 
7

Foreign exchange contracts

 

 
35

 
30

 

 

 
35

 
30

Cross-currency contracts

 

 
44

 

 

 

 
44

 

Total fair value
$
28

 
$
7

 
$
728

 
$
79

 
$

 
$

 
$
756

 
$
86

Our derivative financial instruments are subject to master netting arrangements that allow for the offset of assets and liabilities in the event of default or early termination of the contract. We elect to record the gross assets and liabilities of our derivative financial instruments on the consolidated balance sheets. If the derivative financial instruments had been netted on the consolidated balance sheets, the asset and liability positions each would have been reduced by $56 million at September 30, 2017 and $67 million at December 31, 2016. No material amounts of collateral were received or posted on our derivative assets and liabilities at September 30, 2017.
Level 1 financial assets and liabilities consist of commodity future and options contracts and are valued using quoted prices in active markets for identical assets and liabilities.
Level 2 financial assets and liabilities consist of commodity forwards, foreign exchange forwards, and cross-currency swaps. Commodity forwards are valued using an income approach based on the observable market commodity index prices less the contract rate multiplied by the notional amount. Foreign exchange forwards are valued using an income approach based on observable market forward rates less the contract rate multiplied by the notional amount. Cross-currency swaps are valued based on observable market spot and swap rates.
Our calculation of the fair value of financial instruments takes into consideration the risk of nonperformance, including counterparty credit risk.
There have been no transfers between Levels 1, 2, and 3 in any period presented.

18


The fair values of our derivative assets are recorded within other current assets and other assets. The fair values of our liability derivatives are recorded within other current liabilities and other liabilities.
Net Investment Hedging:
At September 30, 2017, the principal amounts of foreign denominated debt designated as net investment hedges totaled €2,550 million and £400 million.
At September 30, 2017, our cross-currency swaps designated as net investment hedges consisted of:
Instrument
 
Notional
(local)
(in billions)
 
Notional
(USD)
(in billions)
 
Maturity
Cross-currency swap
 
£
0.8

 
$
1.4

 
October 2019
Cross-currency swap
 
C$
1.8

 
$
1.6

 
December 2019
We also periodically enter into shorter-dated foreign exchange contracts that are designated as net investment hedges. At September 30, 2017, we had Chinese renminbi foreign exchange contracts with an aggregate USD notional amount of $208 million.
Hedge Coverage:
At September 30, 2017, we had entered into contracts designated as hedging instruments, which hedge transactions for the following durations:
foreign exchange contracts for periods not exceeding the next 18 months; and
cross-currency contracts for periods not exceeding the next 27 months.
At September 30, 2017, we had entered into contracts not designated as hedging instruments, which hedge economic risks for the following durations:
commodity contracts for periods not exceeding the next 15 months; and
foreign exchange contracts for periods not exceeding the next five months.
Hedge Ineffectiveness:
We record pre-tax gains or losses reclassified from accumulated other comprehensive income/(losses) due to ineffectiveness for foreign exchange contracts related to forecasted transactions in other expense/(income), net.
Deferred Hedging Gains and Losses:
Based on our valuation at September 30, 2017 and assuming market rates remain constant through contract maturities, we expect transfers to net income/(loss) of unrealized losses for foreign currency cash flow hedges during the next 12 months to be $21 million. Additionally, we expect transfers to net income/(loss) of unrealized losses for interest rate cash flow hedges during the next 12 months to be insignificant.

19


Derivative Impact on the Statements of Income and Statements of Comprehensive Income:
The following tables present the pre-tax effect of derivative instruments on the consolidated statements of income and statements of comprehensive income:
 
For the Three Months Ended
 
September 30,
2017
 
October 2,
2016
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate
Contracts
 
(in millions)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) recognized in other comprehensive income/(loss) (effective portion)
$

 
$
(76
)
 
$

 
$

 
$

 
$
33

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) recognized in other comprehensive income/(loss) (effective portion)

 
(6
)
 
(81
)
 

 

 

 
49

 

Total gains/(losses) recognized in other comprehensive income/(loss) (effective portion)
$

 
$
(82
)
 
$
(81
)
 
$

 
$

 
$
33

 
$
49

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges reclassified to net income/(loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Cost of products sold (effective portion)

 
2

 

 

 

 
1

 

 

Other expense/(income), net

 
(52
)
 

 

 

 
23

 

 

Interest expense

 

 

 
(1
)
 

 

 

 
(1
)
 

 
(50
)
 

 
(1
)
 

 
24

 

 
(1
)
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) on derivatives recognized in cost of products sold
4

 

 

 

 
(17
)
 

 

 

Gains/(losses) on derivatives recognized in other expense/(income), net

 
27

 

 

 

 
(4
)
 
2

 

 
4

 
27

 

 

 
(17
)
 
(4
)
 
2

 

Total gains/(losses) recognized in statements of income
$
4

 
$
(23
)
 
$

 
$
(1
)
 
$
(17
)
 
$
20

 
$
2

 
$
(1
)


20


 
For the Nine Months Ended
 
September 30,
2017
 
October 2,
2016
 
Commodity Contracts
 
Foreign Exchange Contracts
 
Cross-Currency Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Foreign Exchange Contracts
 
Cross-Currency Contracts
 
Interest Rate Contracts
 
(in millions)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) recognized in other comprehensive income/(loss) (effective portion)
$

 
$
(147
)
 
$

 
$

 
$

 
$
(4
)
 
$

 
$
(8
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) recognized in other comprehensive income/(loss) (effective portion)

 
(18
)
 
(177
)