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 October 2, 2016
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
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=11213827&doc=12
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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer o
Accelerated filer o
 
Non-accelerated filer x
(Do not check if a smaller reporting company)
Smaller reporting company 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 30, 2016, there were 1,217,270,219 shares of the registrant’s common stock outstanding.




The Kraft Heinz Company
Table of Contents
 
Page No.

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
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Net sales
$
6,267

 
$
6,120

 
$
19,630

 
$
11,214

Cost of products sold
4,049

 
4,492

 
12,503

 
7,857

Gross profit
2,218

 
1,628

 
7,127

 
3,357

Selling, general and administrative expenses
805

 
1,229

 
2,565

 
2,005

Operating income
1,413

 
399

 
4,562

 
1,352

Interest expense
311

 
460

 
824

 
1,055

Other expense/(income), net
(3
)
 
108

 
(5
)
 
314

Income/(loss) before income taxes
1,105

 
(169
)
 
3,743

 
(17
)
Provision for/(benefit from) income taxes
262

 
(49
)
 
1,045

 
(16
)
Net income/(loss)
843

 
(120
)
 
2,698

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

 
3

 
10

 
10

Net income/(loss) attributable to Kraft Heinz
842

 
(123
)
 
2,688

 
(11
)
Preferred dividends

 
180

 
180

 
540

Net income/(loss) attributable to common shareholders
$
842

 
$
(303
)
 
$
2,508

 
$
(551
)
Per share data applicable to common shareholders:
 
 
 
 
 
 
 
Basic earnings/(loss)
$
0.69

 
$
(0.27
)
 
$
2.06

 
$
(0.87
)
Diluted earnings/(loss)
0.69

 
(0.27
)
 
2.05

 
(0.87
)
Dividends declared
0.60

 
0.55

 
1.75

 
0.55


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
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Net income/(loss)
$
843

 
$
(120
)
 
$
2,698

 
$
(1
)
Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(148
)
 
(1,023
)
 
(294
)
 
(1,456
)
Net deferred gains/(losses) on net investment hedges
34

 
195

 
79

 
421

Net postemployment benefit gains/(losses) arising during the period
(145
)
 
892

 
(145
)
 
873

Reclassification of net postemployment benefit losses/(gains)
(39
)
 
(11
)
 
(143
)
 
(4
)
Net deferred gains/(losses) on cash flow hedges
31

 
45

 
(1
)
 
(32
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income
(26
)
 
(9
)
 
(44
)
 
129

Total other comprehensive income/(loss)
(293
)
 
89

 
(548
)
 
(69
)
Total comprehensive income/(loss)
550

 
(31
)
 
2,150

 
(70
)
Comprehensive income/(loss) attributable to noncontrolling interest
3

 
(14
)
 
19

 
(20
)
Comprehensive income/(loss) attributable to Kraft Heinz
$
547

 
$
(17
)
 
$
2,131

 
$
(50
)

See accompanying notes to the condensed consolidated financial statements.

2



The Kraft Heinz Company
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
 
October 2, 2016
 
January 3, 2016
ASSETS
 
 
 
Cash and cash equivalents
$
3,920

 
$
4,837

Trade receivables (net of allowances of $28 at October 2, 2016 and $32 at January 3, 2016)
855

 
871

Sold receivables
208

 
583

Inventories
3,108

 
2,618

Other current assets
852

 
871

Total current assets
8,943

 
9,780

Property, plant and equipment, net
6,490

 
6,524

Goodwill
44,518

 
43,051

Intangible assets, net
59,620

 
62,120

Other assets
1,509

 
1,498

TOTAL ASSETS
$
121,080

 
$
122,973

LIABILITIES AND EQUITY
 
 
 
Commercial paper and other short-term debt
$
653

 
$
4

Current portion of long-term debt
2,047

 
79

Trade payables
3,456

 
2,844

Accrued marketing
708

 
856

Accrued postemployment costs
164

 
328

Income taxes payable
142

 
417

Interest payable
311

 
401

Dividends payable
769

 
762

Other current liabilities
1,164

 
1,241

Total current liabilities
9,414

 
6,932

Long-term debt
29,980

 
25,151

Deferred income taxes
20,706

 
21,497

Accrued postemployment costs
2,367

 
2,405

Other liabilities
745

 
752

TOTAL LIABILITIES
63,212

 
56,737

Commitments and Contingencies (Note 12)

 

Redeemable noncontrolling interest

 
23

9.00% cumulative compounding preferred stock, Series A, no shares authorized and issued at October 2, 2016 and 80,000 authorized and issued shares at January 3, 2016, $0.01 par value

 
8,320

Equity:
 
 
 
Common stock, $0.01 par value (5,000,000,000 shares authorized at October 2, 2016 and January 3, 2016; 1,218,595,543 shares issued and 1,217,580,024 shares outstanding at October 2, 2016; 1,214,391,614 shares issued and 1,213,978,752 shares outstanding at January 3, 2016)
12

 
12

Additional paid-in capital
58,567

 
58,375

Retained earnings/(deficit)
374

 

Accumulated other comprehensive income/(losses)
(1,229
)
 
(671
)
Treasury stock, at cost
(82
)
 
(31
)
Total shareholders' equity
57,642

 
57,685

Noncontrolling interest
226

 
208

TOTAL EQUITY
57,868

 
57,893

TOTAL LIABILITIES AND EQUITY
$
121,080

 
$
122,973


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 January 3, 2016
$
12

 
$
58,375

 
$

 
$
(671
)
 
$
(31
)
 
$
208

 
$
57,893

Net income/(loss) excluding redeemable noncontrolling interest

 

 
2,688

 

 

 
10

 
2,698

Other comprehensive income/(loss) excluding redeemable noncontrolling interest

 

 

 
(558
)
 

 
8

 
(550
)
Dividends declared-Series A Preferred Stock

 

 
(180
)
 

 

 

 
(180
)
Dividends declared-common stock

 

 
(2,130
)
 

 

 

 
(2,130
)
Exercise of stock options, issuance of other stock awards, and other

 
192

 
(4
)
 

 
(51
)
 

 
137

Balance at October 2, 2016
$
12

 
$
58,567

 
$
374

 
$
(1,229
)
 
$
(82
)
 
$
226

 
$
57,868


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
 
October 2, 2016
 
September 27, 2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income/(loss)
$
2,698

 
$
(1
)
Adjustments to reconcile net income/(loss) to operating cash flows:
 
 
 
Depreciation and amortization
1,010

 
402

Amortization of postretirement benefit plans prior service credits
(217
)
 
(31
)
Equity award compensation expense
38

 
98

Deferred income tax provision
(28
)
 
(562
)
Pension contributions
(332
)
 
(47
)
Nonmonetary currency devaluation
18

 
234

Other items, net
(140
)
 
508

Changes in current assets and liabilities:
 
 
 
Trade receivables
32

 
196

Sold receivables
375

 
78

Inventories
(481
)
 
23

Accounts payable
480

 
(97
)
Other current assets
(58
)
 
22

Other current liabilities
(529
)
 
(77
)
Net cash provided by/(used for) operating activities
2,866

 
746

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital expenditures
(836
)
 
(366
)
Payments to acquire Kraft Foods Group, Inc., net of cash acquired

 
(9,468
)
Proceeds from net investment hedges
84

 
481

Other investing activities, net
10

 
(48
)
Net cash provided by/(used for) investing activities
(742
)
 
(9,401
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayments of long-term debt
(74
)
 
(12,308
)
Proceeds from issuance of long-term debt
6,981

 
14,823

Proceeds from issuance of commercial paper
4,296

 

Repayments of commercial paper
(3,660
)
 

Proceeds from issuance of common stock

 
10,000

Dividends paid-Series A Preferred Stock
(180
)
 
(540
)
Dividends paid-common stock
(2,123
)
 
(637
)
Redemption of Series A Preferred Stock
(8,320
)
 

Other financing activities, net
56

 
(147
)
Net cash provided by/(used for) financing activities
(3,024
)
 
11,191

Effect of exchange rate changes on cash and cash equivalents
(17
)
 
(397
)
Cash and cash equivalents:
 
 
 
Net increase/(decrease)
(917
)
 
2,139

Balance at beginning of period
4,837

 
2,298

Balance at end of period
$
3,920

 
$
4,437


See accompanying notes to the condensed consolidated financial statements.

5



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 present fairly our results for the periods presented.
The condensed consolidated balance sheet data at January 3, 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 January 3, 2016. The results for interim periods are not necessarily indicative of future or annual results.
Organization:
On July 2, 2015 (the “2015 Merger Date”), through a series of transactions, we consummated the merger of Kraft Foods Group, Inc. (“Kraft”) with and into a wholly-owned subsidiary of H.J. Heinz Holding Corporation (“Heinz”) (the “2015 Merger”). At the closing of the 2015 Merger, Heinz was renamed The Kraft Heinz Company (“Kraft Heinz”).
Before the consummation of the 2015 Merger, Heinz was controlled by Berkshire Hathaway Inc. and 3G Global Food Holdings, L.P. (together, the “Sponsors”), following their acquisition of H. J. Heinz Company (the “2013 Merger”) on June 7, 2013 (the “2013 Merger Date”).
Changes in Accounting and Reporting:
Consistent with our consolidated financial statements in our Annual Report on Form 10-K for the year ended January 3, 2016, we separately presented sold receivables on our consolidated balance sheets and consolidated statements of cash flows. Our prior period cash flow balances have been reclassified to conform with the current period presentation.
Recently Issued Accounting Standards:
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update (“ASU”) that 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 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 retrospectively to historical periods presented or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.
In September 2015, the FASB issued an ASU intended to simplify the accounting for measurement period adjustments in a business combination. Measurement period adjustments are changes to provisional amounts recorded when the accounting for a business combination is incomplete as of the end of a reporting period. The measurement period can extend for up to a year following the transaction date. During the measurement period, companies may make adjustments to provisional amounts when information necessary to complete the measurement is received. The ASU requires companies to recognize these adjustments, including any related impacts to net income, in the reporting period in which the adjustments are determined. Companies are no longer required to retroactively apply measurement period adjustments to all periods presented. We early adopted this ASU in 2015. See Note 2, Merger and Acquisition, for additional information on measurement period adjustments related to the 2015 Merger.
In February 2016, the FASB issued an ASU that 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 sheet 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. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures, but we expect that the adoption will significantly increase the assets and liabilities on our consolidated balance sheets.
In March 2016, the FASB issued an ASU intended to simplify equity-based award accounting and presentation. The ASU impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. This ASU will be effective beginning in the first quarter of our fiscal year 2017. Early adoption is permitted. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.

6



In August 2016, the FASB issued an ASU related to the classification of certain cash payments and cash receipts on the statement of cash flows. This ASU provides guidance on eight specific cash flow classification matters in order to reduce current and future diversity in practice. The ASU will be effective beginning in the first quarter of our fiscal year 2018. Early adoption is permitted. The guidance related to each of the eight separate classification matters must be adopted in the same period using a retrospective transition method. We are currently evaluating the impact that this ASU will have on our financial statements and related disclosures.
Note 2. Merger and Acquisition
Transaction Overview:
The 2015 Merger was accounted for under the acquisition method of accounting for business combinations and Heinz was considered to be the acquiring company. Under the acquisition method of accounting, total consideration exchanged was (in millions):
Aggregate fair value of Kraft common stock
$
42,502

$16.50 per share special cash dividend
9,782

Fair value of replacement equity awards
353

Total consideration exchanged
$
52,637

Valuation Assumptions and Purchase Price Allocation:
We utilized estimated fair values at the 2015 Merger Date to allocate the total consideration exchanged to the net tangible and intangible assets acquired and liabilities assumed. Such allocation was final as of July 3, 2016.
During the first half of 2016, we made measurement period adjustments to the preliminary purchase price allocation primarily reflecting (i) a decrease in indefinite-lived intangible assets of $2.0 billion, (ii) a decrease in deferred income tax liabilities of $564 million, and (iii) an increase in goodwill of $1.4 billion. We made these measurement period adjustments to reflect facts and circumstances that existed as of the 2015 Merger Date and did not result from intervening events subsequent to such date.
The final purchase price allocation to assets acquired and liabilities assumed in the transaction was (in millions):
Cash
$
314

Other current assets
3,423

Property, plant and equipment
4,179

Identifiable intangible assets
47,771

Other non-current assets
214

Trade and other payables
(3,026
)
Long-term debt
(9,286
)
Net postemployment benefits and other non-current liabilities
(4,739
)
Deferred income tax liabilities
(16,675
)
Net assets acquired
22,175

Goodwill on acquisition
30,462

Total consideration
52,637

Fair value of shares exchanged and equity awards
42,855

Total cash consideration paid to Kraft shareholders
9,782

Cash and cash equivalents of Kraft at the 2015 Merger Date
314

Acquisition of business, net of cash on hand
$
9,468

The 2015 Merger resulted in $30.5 billion of non tax deductible goodwill relating principally to synergies expected to be achieved from the combined operations and planned growth in new markets. Goodwill has been allocated to our segments as shown in Note 5, Goodwill and Intangible Assets.

7



Pro Forma Results:
The following table provides unaudited pro forma results, prepared in accordance with ASC 805, for the three and nine months ended September 27, 2015, as if Kraft had been acquired as of December 30, 2013.
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 27, 2015
 
September 27, 2015
 
(in millions, except per share data)
Net sales
$
6,363

 
$
20,323

Net income
12

 
1,116

Basic earnings per share
(0.14
)
 
0.48

Diluted earnings per share
(0.14
)
 
0.47

The unaudited pro forma results include certain purchase accounting adjustments. We have made pro forma adjustments to exclude deal costs of $96 million ($59 million net of tax) for the three months and $166 million ($102 million net of tax) for the nine months ended September 27, 2015, and to exclude $347 million ($213 million net of tax) of non-cash costs related to the fair value step-up of Kraft’s inventory (“Inventory Step-up Costs”) for the three and nine months ended September 27, 2015, because such costs are non-recurring and are directly attributable to the 2015 Merger. These expenses were included in the prior year pro forma results.
The unaudited pro forma results do not include any anticipated cost savings or other effects of future integration or restructuring efforts. Unaudited pro forma amounts are not necessarily indicative of results had the 2015 Merger occurred on December 30, 2013 or of future results.
Note 3. Integration and Restructuring Expenses
Following the 2015 Merger, we announced a multi-year program (the “Integration Program”) designed to reduce costs, as well as integrate and optimize the combined organization. As part of the Integration Program, we incur expenses (primarily employee separations, lease terminations, and other direct exit costs) that qualify as exit and disposal costs under U.S. GAAP. 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 (primarily accelerated depreciation, asset impairments, implementation costs such as new facility relocation and start-up costs, and other incremental costs).

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. Asset-related costs consist primarily of accelerated depreciation and, to a lesser degree, asset impairments. 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:
We currently expect the Integration Program will result in $1.9 billion of pre-tax costs, with approximately 60% reflected in cost of products sold, comprised of the following categories:
Organization costs ($650 million) associated with our plans to streamline and simplify our operating structure, resulting in workforce reduction. These costs primarily include severance and employee benefits (cash severance, non-cash severance, including accelerated equity award compensation expense, and pension and other termination benefits). In August 2015, we announced a new, streamlined structure for our businesses in the United States and Canada segments. This resulted in the reduction of salaried positions across the United States and Canada. Overall, we expect to eliminate 3,350 positions in connection with this reduction.
Footprint costs ($1.1 billion) associated with our plans to optimize our production and supply chain network, resulting in facility closures and consolidations. These costs primarily include asset-related costs (accelerated depreciation and asset impairment charges), costs to exit facilities, relocation and start-up costs of new facilities, and severance and employee benefits. On November 4, 2015, we announced our plans to close seven factories and began a consolidation of our distribution network. On September 13, 2016, we announced that one of the previously announced seven factories, our Fullerton, California factory, would remain open. In a staged process, production in the other six locations is shifting to

8



other existing factories in the United States and Canada. Overall, we expect to close six factories and eliminate 1,900 positions in connection with these activities.
Other costs ($150 million) incurred as a direct result of integration activities, primarily including contract and lease terminations, professional fees, and other incremental third-party fees.
As of October 2, 2016, we have incurred approximately $1.6 billion of cumulative costs under the Integration Program, including: $676 million of severance and employee benefit costs, $539 million of non-cash asset-related costs, $241 million of other implementation costs, and $95 million of other exit costs. We expect that approximately 60% of the Integration Program expenses will be cash expenditures. Our Integration Program costs during the three and nine months ended October 2, 2016 were (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
October 2, 2016
 
October 2, 2016
Severance and employee benefit costs
$
56

 
$
114

Asset-related costs
98

 
403

Other exit costs
15

 
40

Other implementation costs
53

 
165

 
$
222

 
$
722

At October 2, 2016, the total Integration Program liability related primarily to the elimination of general salaried and footprint-related positions across the United States and Canada, 3,250 of whom have left the company by October 2, 2016. The liability balance associated with the Integration Program, which qualifies as U.S. GAAP exit and disposal costs, was (in millions):
 
Severance and Employee Benefit Costs
 
Other Exit Costs(a)
 
Total
Balance at January 3, 2016
$
185

 
$
23

 
$
208

Charges
114

 
40

 
154

Cash payments
(153
)
 
(48
)
 
(201
)
Non-cash utilization
(25
)
 

 
(25
)
Balance at October 2, 2016
$
121

 
$
15

 
$
136

(a) Other exit costs primarily represent contract and lease terminations.
We expect that a substantial portion of the Integration Program liability as of October 2, 2016 will be paid in 2016.
Restructuring Activities:
Prior to the 2015 Merger, we executed a number of other restructuring activities focused primarily on workforce reduction and factory closure and consolidation, which were substantially complete as of October 2, 2016. These programs, and other programs, resulted in the elimination of 8,250 positions and cumulative $569 million severance and employee benefit costs, $337 million non-cash asset-related costs, and $390 million other exit costs through October 2, 2016. Related to these restructuring activities, we incurred expenses of $15 million for the three months and $59 million for the nine months ended October 2, 2016.
As of October 2, 2016, the liability balance associated with active restructuring projects, which qualifies as U.S. GAAP exit and disposal costs, was (in millions):
 
Severance and Employee Benefit Costs
 
Other Exit Costs(a)
 
Total
Balance at January 3, 2016
$
25

 
$
30

 
$
55

Charges
18

 
1

 
19

Cash payments
(31
)
 
(5
)
 
(36
)
Balance at October 2, 2016
$
12

 
$
26

 
$
38

(a) Other exit costs primarily represent contract and lease terminations.
We expect that a substantial portion of the active restructuring projects liability as of October 2, 2016 will be paid in 2016.


9



Total Integration and Restructuring:
Our total Integration Program and restructuring expenses recorded in cost of products sold and selling, general and administrative expenses (“SG&A”) were (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Severance and employee benefit costs - COGS
$
14

 
$
85

 
$
43

 
$
104

Severance and employee benefit costs - SG&A
43

 
311

 
89

 
324

Asset-related costs - COGS
89

 
49

 
368

 
83

Asset-related costs - SG&A
9

 

 
35

 

Other exit costs - COGS
49

 
25

 
121

 
48

Other exit costs - SG&A
33

 
12

 
125

 
28

 
$
237

 
$
482

 
$
781

 
$
587

We do not include Integration Program and restructuring expenses within Segment Adjusted EBITDA. See Note 14, Segment Reporting, for additional information on our segment structure. 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
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
United States
$
161

 
$
365

 
$
607

 
$
405

Canada
16

 
39

 
43

 
51

Europe
4

 
72

 
32

 
106

Rest of World
1

 
1

 
1

 
10

Non-Operating
55

 
5

 
98

 
15

 
$
237

 
$
482

 
$
781

 
$
587

Note 4. Inventories
Inventories at October 2, 2016 and January 3, 2016 were (in millions):
 
October 2, 2016
 
January 3, 2016
Packaging and ingredients
$
656

 
$
563

Work in process
405

 
393

Finished product
2,047

 
1,662

Inventories
$
3,108

 
$
2,618

The increase in inventories as of October 2, 2016 was primarily due to an increase in inventory production ahead of planned facility closures and consolidations under our Integration Program, combined with the impact of seasonality. See Note 3, Integration and Restructuring Expenses, for additional information on the Integration Program.
Note 5. Goodwill and Intangible Assets
Goodwill:
Changes in the carrying amount of goodwill from January 3, 2016 to October 2, 2016, by segment, were (in millions):
 
United States
 
Canada
 
Europe
 
Rest of World
 
Total
Balance at January 3, 2016
$
32,290

 
$
4,796

 
$
3,182

 
$
2,783

 
$
43,051

2015 Merger measurement period adjustments
1,433

 

 

 

 
1,433

Translation adjustments

 
251

 
(311
)
 
94

 
34

Balance at October 2, 2016
$
33,723

 
$
5,047

 
$
2,871

 
$
2,877

 
$
44,518

In connection with the 2015 Merger, we recorded $30.5 billion of goodwill in purchase accounting, representing the fair value as of the 2015 Merger Date. As of July 3, 2016, the assignment of goodwill to reporting units was final. During the first half of 2016, we made measurement period adjustments to the 2015 Merger purchase price allocation, resulting in an increase of $1.4 billion

10



to goodwill in the United States segment. See Note 2, Merger and Acquisition, for additional information on these measurement period adjustments.
In the first quarter of 2016, we moved certain of our export businesses and their related goodwill balances from our United States segment to our Rest of World and Europe segments. We have reflected this change in all historical periods presented. Accordingly, the segment goodwill balances at January 3, 2016 reflect a decrease of $1,473 million in the United States, an increase of $1,443 million in Rest of World, and an increase of $30 million in Europe. These amounts represent the final allocation of goodwill associated with these export businesses.
In the third quarter of 2016, we announced planned changes to our segment structure. We expect that these changes will become effective December 31, 2016. For additional information on these changes, see Note 14, Segment Reporting, to the condensed consolidated financial statements.
We test goodwill for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2016 annual impairment testing in the second quarter of 2016. There was no impairment of goodwill as a result of our testing; however we noted that one reporting unit within the Rest of World segment had an estimated fair value in excess of its carrying value of less than 10%. The goodwill carrying value of this reporting unit was $48 million as of April 4, 2016 (our goodwill impairment testing date).
Our goodwill balance consists of a large number of individual reporting units and had an aggregate carrying value of $44.5 billion as of October 2, 2016. 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 is not a significant excess of fair values over carry values as of October 2, 2016. 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 October 2, 2016 that indicated it was more likely than not that our goodwill was impaired. There were no accumulated impairment losses to goodwill as of October 2, 2016.
Indefinite-lived intangible assets:
In connection with the 2015 Merger, we recorded $43.1 billion of indefinite-lived intangible assets in purchase accounting, representing the fair values as of the 2015 Merger Date.
Indefinite-lived intangible assets, which primarily consisted of trademarks, were (in millions):
Balance at January 3, 2016
$
55,824

2015 Merger measurement period adjustments
(1,978
)
Translation adjustments
(328
)
Balance at October 2, 2016
$
53,518

We test indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2016 annual impairment testing in the second quarter of 2016. There was no impairment of indefinite-lived intangibles as a result of our testing; however, we noted that seven brands each had excess fair value over its carrying value of less than 10%. These brands had an aggregate carrying value of $6.1 billion at April 4, 2016 (our indefinite-lived intangible asset impairment testing date). Of the $6.1 billion aggregate carrying value, $5.6 billion was attributable to Velveeta, Lunchables, Maxwell House, and Cracker Barrel.
Our indefinite-lived intangible assets primarily consist of a large number of individual brands and had an aggregate carrying value of $53.5 billion as of October 2, 2016. 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 is not a significant excess of fair values over carry values as of October 2, 2016. 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 October 2, 2016 that indicated it was more likely than not that our indefinite-lived intangible assets were impaired.

11



Definite-lived intangible assets:
Definite-lived intangible assets at October 2, 2016 and January 3, 2016 were (in millions):
 
October 2, 2016
 
January 3, 2016
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
Trademarks
$
2,357

 
$
(148
)
 
$
2,209

 
$
2,346

 
$
(70
)
 
$
2,276

Customer-related assets
4,217

 
(333
)
 
3,884

 
4,218

 
(209
)
 
4,009

Other
12

 
(3
)
 
9

 
15

 
(4
)
 
11

 
$
6,586

 
$
(484
)
 
$
6,102

 
$
6,579

 
$
(283
)
 
$
6,296

Amortization expense for definite-lived intangible assets was $66 million for the three months and $198 million for the nine months ended October 2, 2016 and was $66 million for the three months and $111 million for the nine months ended September 27, 2015. Aside from amortization expense, the changes in definite-lived intangible assets from January 3, 2016 to October 2, 2016 reflect the impact of foreign currency. We estimate that annual amortization expense for definite-lived intangible assets for each of the next five years will be approximately $275 million.
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 income tax rate is a composite rate reflecting the earnings and applicable tax rates in various locations.
The effective tax rate was an expense of 23.7% for the three months and 27.9% for the nine months ended October 2, 2016, in comparison to the benefit of 29.1% for the three months and 92.4% for the nine months ended September 27, 2015. Our current effective tax rate reflects the favorable benefit of non-U.S. jurisdictions with lower tax rates, the U.S. manufacturing deduction, as well as the deferred tax effect of statutory tax rate changes and adjustments. The change in our effective tax rate for the three and nine months ended October 2, 2016 compared to the three and nine months ended September 27, 2015 was driven by the 2015 Merger as well as the impact of tax law changes and deferred tax adjustments. With the 2015 Merger, our operations in the United States and Canada increased, resulting in an unfavorable impact to the effective tax rate of higher blended statutory tax rates and a favorable impact to the effective tax rate of a larger U.S. manufacturing deduction.
Note 7. Employees’ Stock Incentive Plans
Our annual equity award grants and vesting occurred in the first quarter of 2016. 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 January 3, 2016
24,205,612

 
$
34.86

Options granted
1,466,626

 
79.78

Options forfeited
(760,613
)
 
49.51

Options exercised
(3,701,021
)
 
35.04

Outstanding at October 2, 2016
21,210,604

 
37.41

The aggregate intrinsic value of stock options exercised during the period was $170 million for the nine months ended October 2, 2016.

12



Restricted Stock Units:
Our restricted stock unit (“RSU”) activity and related information was:
 
Number of Units
 
Weighted Average Grant Date Fair Value
(per share)
RSUs at January 3, 2016
968,444

 
$
70.14

Granted
503,659

 
77.52

Forfeited
(118,585
)
 
75.12

Vested
(489,631
)
 
72.96

RSUs at October 2, 2016
863,887

 
72.12

The aggregate fair value of RSUs that vested during the period was $38 million for the nine months ended October 2, 2016.
Total Equity Awards:
The compensation cost related to equity awards was primarily recognized in general corporate expenses within SG&A. Equity award compensation cost and the related tax benefit was (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Pre-tax compensation cost
$
12

 
$
91

 
$
38

 
$
98

Tax benefit
(4
)
 
(34
)
 
(12
)
 
(37
)
After-tax compensation cost
$
8

 
$
57

 
$
26

 
$
61

Unrecognized compensation cost related to unvested equity awards was $97 million at October 2, 2016 and is expected to be recognized over a weighted average period of three years.
Note 8. Postemployment Benefits
In the first quarter of 2016, we changed the method that we use to estimate the service cost and interest cost components of net pension cost/(benefit) and net postretirement cost/(benefit). We use a full yield curve approach to estimate service cost and interest cost by applying the specific spot rates along the yield curve used to determine the benefit obligation to the relevant projected cash flows. Previously, we estimated service cost and interest cost using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. We made this change to provide a more precise measurement of service cost and interest cost by improving the correlation between projected benefit cash flows and the corresponding spot yield curve rates. The change resulted in a decrease in service and interest cost of approximately $20 million in the three months ended October 2, 2016 and approximately $60 million in the nine months ended October 2, 2016 compared to what our costs would have been under the previous method. This change did not affect the measurement of our total benefit obligations. We have accounted for this change prospectively as a change in accounting estimate.

13



Pension Plans
Components of Net Pension Cost/(Benefit):
Net pension cost/(benefit) consisted of the following for the three and nine months ended October 2, 2016 and September 27, 2015 (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
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Service cost
$
3

 
$
22

 
$
6

 
$
8

 
$
10

 
$
25

 
$
18

 
$
18

Interest cost
52

 
82

 
21

 
30

 
158

 
91

 
64

 
73

Expected return on plan assets
(73
)
 
(86
)
 
(44
)
 
(55
)
 
(221
)
 
(94
)
 
(137
)
 
(140
)
Amortization of unrecognized losses/(gains)

 
1

 

 

 

 
3

 

 

Settlements
26

 

 

 
8

 
20

 

 

 
19

Curtailments

 
(1
)
 

 
(7
)
 

 
(1
)
 

 
(9
)
Special/contractual termination benefits

 
3

 

 
4

 

 
3

 

 
4

Net pension cost/(benefit)
$
8

 
$
21

 
$
(17
)
 
$
(12
)
 
$
(33
)
 
$
27

 
$
(55
)
 
$
(35
)
We capitalized a portion of net pension costs/(benefits) into inventory based on our production activities. These amounts are included in the table above.
In the third quarter of 2016, we approved the wind up of our Canadian salaried and Canadian hourly defined benefit pension plans effective December 31, 2016. This action had no impact on the condensed consolidated statements of income, condensed consolidated balance sheets, or condensed consolidated statements of cash flows as at and for the three and nine months ended October 2, 2016.
Employer Contributions:
During the nine months ended October 2, 2016, we contributed $311 million to our U.S. pension plans, which included contributions related to the settlement of our U.S. nonqualified pension plan that was terminated effective December 31, 2015. During the nine months ended October 2, 2016, we contributed $21 million to our non-U.S. pension plans. Based on our contribution strategy, we plan to make further contributions of up to approximately $5 million to our non-U.S. plans during the remainder of 2016. We are not planning to make any further contributions to our U.S. plans during the remainder of 2016. However, our actual contributions and plans may change due to many factors, including changes in tax, employee benefit or other laws, 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 for the three and nine months ended October 2, 2016 and September 27, 2015 (in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Service cost
$
3

 
$
7

 
$
11

 
$
9

Interest cost
13

 
33

 
43

 
37

Amortization of prior service costs/(credits)
(90
)
 
(28
)
 
(252
)
 
(31
)
Curtailments

 
1

 

 
1

Net postretirement cost/(benefit)
$
(74
)
 
$
13

 
$
(198
)
 
$
16

We capitalized a portion of net postretirement costs/(benefits) into inventory based on our production activities. These amounts are included in the table above.

14



Note 9. Accumulated Other Comprehensive Income/(Losses)
The components of, and changes in, accumulated other comprehensive income/(losses) were as follows (net of tax):
 
Foreign Currency Translation Adjustments
 
Net Postemployment Benefit Plan Adjustments
 
Net Cash Flow Hedge Adjustments
 
Total
 
(in millions)
Balance as of January 3, 2016
$
(1,646
)
 
$
922

 
$
53

 
$
(671
)
Foreign currency translation adjustments
(304
)
 

 

 
(304
)
Net deferred gains/(losses) on net investment hedges
79

 

 

 
79

Net postemployment benefit gains/(losses)

 
(145
)
 

 
(145
)
Reclassification of net postemployment benefit losses/(gains)

 
(143
)
 

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

 

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

 

 
(44
)
 
(44
)
Total other comprehensive income/(loss)
(225
)
 
(288
)
 
(45
)
 
(558
)
Balance as of October 2, 2016
$
(1,871
)
 
$
634

 
$
8

 
$
(1,229
)
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) for the three and nine months ended October 2, 2016 and September 27, 2015 were as follows (in millions):
 
For the Three Months Ended
 
October 2, 2016
 
September 27, 2015
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
Foreign currency translation adjustments
$
(151
)
 
$

 
$
(151
)
 
$
(1,006
)
 
$

 
$
(1,006
)
Net deferred gains/(losses) on net investment hedges
34

 

 
34

 
240

 
(45
)
 
195

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

 
(251
)
 
(54
)
 
23

 
(31
)
Prior service credits/(costs) arising during the period
172

 
(66
)
 
106

 
1,500

 
(577
)
 
923

Reclassification of net postemployment benefit losses/(gains)
(64
)
 
25

 
(39
)
 
(19
)
 
8

 
(11
)
Net deferred gains/(losses) on cash flow hedges
33

 
(2
)
 
31

 
53

 
(8
)
 
45

Net deferred losses/(gains) on cash flow hedges reclassified to net income
(23
)
 
(3
)
 
(26
)
 
(15
)
 
6

 
(9
)
 
For the Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
 
Before Tax Amount
 
Tax
 
Net of Tax Amount
Foreign currency translation adjustments
$
(304
)
 
$

 
$
(304
)
 
$
(1,426
)
 
$

 
$
(1,426
)
Net deferred gains/(losses) on net investment hedges
144

 
(65
)
 
79

 
661

 
(240
)
 
421

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

 
(251
)
 
(79
)
 
29

 
(50
)
Prior service credits/(costs) arising during the period
172

 
(66
)
 
106

 
1,500

 
(577
)
 
923

Reclassification of net postemployment benefit losses/(gains)
(232
)
 
89

 
(143
)
 
(9
)
 
5

 
(4
)
Net deferred gains/(losses) on cash flow hedges
(12
)
 
11

 
(1
)
 
(67
)
 
35

 
(32
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income
(43
)
 
(1
)
 
(44
)
 
207

 
(78
)
 
129

In the third quarter of 2016, we determined that we had misstated the prior service credit related to the postretirement plan amendment recognized in the third quarter 2015 financial statements. This misstatement had an impact on other comprehensive income/(losses) for the three and nine months ended October 2, 2016 and September 27, 2015. Accordingly, in the third quarter of 2016, we recorded

15



a correction to reduce accrued postemployment costs by $107 million, reduce deferred income taxes by $41 million, and increase accumulated other comprehensive income/(losses) by $66 million on the condensed consolidated balance sheet at October 2, 2016. This correction is reflected in prior service credits/(costs) arising during the period in the tables above. This misstatement was not material to our current or any prior period financial statements.
The amounts reclassified from accumulated other comprehensive income/(losses) in the three and nine months ended October 2, 2016 and September 27, 2015 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 is Presented
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
 
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
 
Losses/(gains) on cash flow hedges:
 
 
 
 
 

 
 


     Foreign exchange contracts
 
$

 
$

 
$
(3
)
 
$
2


Net sales
     Foreign exchange contracts
 
(1
)
 
(16
)
 
(34
)
 
(32
)

Cost of products sold
     Foreign exchange contracts
 
(23
)
 

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

 
1

 
3

 
238


Interest expense
Losses/(gains) on cash flow hedges before income taxes
 
(23
)
 
(15
)
 
(43
)
 
207



Losses/(gains) on cash flow hedges income taxes
 
(3
)
 
6

 
(1
)
 
(78
)


Losses/(gains) on cash flow hedges
 
$
(26
)
 
$
(9
)
 
$
(44
)
 
$
129



 
 
 
 
 
 
 
 
 
 
 
Losses/(gains) on postemployment benefits:
 
 
 
 
 
 
 
 


Amortization of unrecognized losses/(gains)
 
$

 
$
1

 
$

 
$
3

 
(a)
Amortization of prior service costs/(credits)
 
(90
)
 
(28
)
 
(252
)
 
(31
)

(a)
Settlement and curtailments losses/(gains)
 
26

 
8

 
20

 
19


(a)
Losses/(gains) on postemployment benefits before income taxes
 
(64
)
 
(19
)
 
(232
)
 
(9
)


Losses/(gains) on postemployment benefits income taxes
 
25

 
8

 
89

 
5



Losses/(gains) on postemployment benefits
 
$
(39
)
 
$
(11
)
 
$
(143
)
 
$
(4
)


(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 January 3, 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 at October 2, 2016 and January 3, 2016 were (in millions):
 
Notional Amount
 
October 2, 2016
 
January 3, 2016
Commodity contracts
$
475

 
$
787

Foreign exchange contracts
2,466

 
3,458

Cross-currency contracts
3,173

 
4,328


16



Fair Value of Derivative Instruments:
The fair values and the levels within the fair value hierarchy of derivative instruments recorded on the condensed consolidated balance sheets at October 2, 2016 and January 3, 2016 were (in millions):
 
October 2, 2016
 
Quoted Prices in Active Markets for Identical Assets
(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
$

 
$

 
$
32

 
$
17

 
$

 
$

 
$
32

 
$
17

Cross-currency contracts

 

 
479

 

 

 

 
479

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
22

 
10

 

 
2

 

 

 
22

 
12

Foreign exchange contracts

 

 
29

 
19

 

 

 
29

 
19

Cross-currency contracts

 

 
41

 

 

 

 
41

 

Total fair value
$
22

 
$
10

 
$
581

 
$
38

 
$

 
$

 
$
603

 
$
48

 
January 3, 2016
 
Quoted Prices in Active Markets for Identical Assets
(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
$

 
$

 
$
46

 
$
6

 
$

 
$

 
$
46

 
$
6

Cross-currency contracts

 

 
605

 

 

 

 
605

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
24

 
29

 
1

 
7

 

 

 
25

 
36

Foreign exchange contracts

 

 
88

 
13

 

 

 
88

 
13

Cross-currency contracts

 

 
47

 

 

 

 
47

 

Total fair value
$
24

 
$
29

 
$
787

 
$
26

 
$

 
$

 
$
811

 
$
55

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 condensed consolidated balance sheets. If the derivative financial instruments had been netted on the condensed consolidated balance sheets, the asset and liability positions each would have been reduced by $30 million at October 2, 2016 and $44 million at January 3, 2016. No material amounts of collateral were received or posted on our derivative assets and liabilities at October 2, 2016.
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.

17



The fair values of our asset derivatives 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:
In May 2016, we issued €1.8 billion aggregate principal amount of Euro denominated notes (see Note 12, Commitments, Contingencies and Debt). The principal amounts of these foreign denominated notes were designated as net investment hedges. Concurrently, we fully unwound our then-outstanding Euro swap (USD notional amount of $1.1 billion). At October 2, 2016, the principal amounts of foreign denominated debt designated as net investment hedges totaled €2,550 million and £400 million.
At October 2, 2016, 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
Hedge Coverage:
At October 2, 2016, we had entered into contracts designated as hedging instruments, which hedge transactions for the following durations:
foreign currency contracts for periods not exceeding the next two years, and
cross-currency contracts for periods not exceeding the next four years.
At October 2, 2016, 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 12 months,
foreign exchange contracts for periods not exceeding the next 12 months, and
cross-currency contracts for periods not exceeding the next three years.
Hedge Ineffectiveness:
We record pre-tax gains or losses reclassified from accumulated other comprehensive income/(losses) due to ineffectiveness in:
other expense/(income), net for foreign exchange contracts related to forecasted transactions.
Deferred Hedging Gains and Losses:
Based on our valuation at October 2, 2016 and assuming market rates remain constant through contract maturities, we expect transfers to net income/(loss) of unrealized gains for foreign currency cash flow hedges during the next 12 months to be $10 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.

18



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 condensed consolidated statements of income and statements of comprehensive income for the three and nine months ended October 2, 2016 and September 27, 2015 (in millions):
 
For the Three Months Ended
 
October 2, 2016
 
September 27, 2015
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate
Contracts
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) recognized in other comprehensive income (effective portion)
$

 
$
33

 
$

 
$

 
$

 
$
53

 
$

 
$

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

 

 
49

 

 

 

 
218

 

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

 
$
33

 
$
49

 
$

 
$

 
$
53

 
$
218

 
$

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

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Cost of products sold (effective portion)

 
1

 

 

 

 
16

 

 

Other expense/(income), net

 
23

 

 

 

 

 

 

Interest expense

 

 

 
(1
)
 

 

 

 
(1
)
 

 
24

 

 
(1
)
 

 
16

 

 
(1
)
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) on derivatives recognized in cost of products sold
(17
)
 

 

 

 
(21
)
 

 

 

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

 
(4
)
 
2

 

 

 
9

 
46

 
(3
)
 
(17
)
 
(4
)
 
2

 

 
(21
)
 
9

 
46

 
(3
)
Total gains/(losses) recognized in statements of income
$
(17
)
 
$
20

 
$
2

 
$
(1
)
 
$
(21
)
 
$
25

 
$
46

 
$
(4
)


19



 
For the Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Foreign Exchange
Contracts
 
Cross-Currency Contracts
 
Interest Rate
Contracts
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges: