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 June 30, 2018
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=12388107&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, 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 July 28, 2018, there were 1,219,248,231 shares of the registrant’s common stock outstanding.



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.
The Kraft Heinz Company
Condensed Consolidated Statements of Income
(in millions, except per share data)
(Unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Net sales
$
6,686

 
$
6,637

 
$
12,990

 
$
12,961

Cost of products sold
4,321

 
4,204

 
8,380

 
8,329

Gross profit
2,365

 
2,433

 
4,610

 
4,632

Selling, general and administrative expenses
1,036

 
789

 
1,800

 
1,555

Operating income
1,329

 
1,644

 
2,810

 
3,077

Interest expense
318

 
307

 
635

 
620

Other expense/(income), net
(35
)
 
(253
)
 
(125
)
 
(383
)
Income/(loss) before income taxes
1,046

 
1,590

 
2,300

 
2,840

Provision for/(benefit from) income taxes
291

 
430

 
552

 
789

Net income/(loss)
755

 
1,160

 
1,748

 
2,051

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

 
(1
)
 
(1
)
Net income/(loss) attributable to common shareholders
$
756

 
$
1,159

 
$
1,749

 
$
2,052

Per share data applicable to common shareholders:
 
 
 
 
 
 
 
Basic earnings/(loss)
$
0.62

 
$
0.95

 
$
1.43

 
$
1.69

Diluted earnings/(loss)
0.62

 
0.94

 
1.43

 
1.67

Dividends declared
0.625

 
0.60

 
1.25

 
1.20


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 Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Net income/(loss)
$
755

 
$
1,160

 
$
1,748

 
$
2,051

Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(868
)
 
451

 
(671
)
 
758

Net deferred gains/(losses) on net investment hedges
219

 
(152
)
 
145

 
(203
)
Net deferred gains/(losses) on cash flow hedges
34

 
(32
)
 
56

 
(66
)
Net deferred losses/(gains) on cash flow hedges reclassified to net income
(9
)
 
26

 
(22
)
 
46

Net actuarial gains/(losses) arising during the period
53

 
1

 
53

 
(9
)
Prior service credits/(costs) arising during the period

 
1

 

 
1

Net postemployment benefit losses/(gains) reclassified to net income
(17
)
 
(154
)
 
(75
)
 
(209
)
Total other comprehensive income/(loss)
(588
)
 
141

 
(514
)
 
318

Total comprehensive income/(loss)
167

 
1,301

 
1,234

 
2,369

Comprehensive income/(loss) attributable to noncontrolling interest
(7
)
 
1

 
(12
)
 
(3
)
Comprehensive income/(loss) attributable to common shareholders
$
174

 
$
1,300

 
$
1,246

 
$
2,372


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)
 
June 30, 2018
 
December 30, 2017
ASSETS
 
 
 
Cash and cash equivalents
$
3,369

 
$
1,629

Trade receivables (net of allowances of $24 at June 30, 2018 and $23 at December 30, 2017)
1,950

 
921

Sold receivables
37

 
353

Income taxes receivable
177

 
582

Inventories
3,161

 
2,815

Other current assets
807

 
966

Total current assets
9,501

 
7,266

Property, plant and equipment, net
7,258

 
7,120

Goodwill
44,270

 
44,824

Intangible assets, net
59,101

 
59,449

Other assets
1,766

 
1,573

TOTAL ASSETS
$
121,896

 
$
120,232

LIABILITIES AND EQUITY
 
 
 
Commercial paper and other short-term debt
$
34

 
$
460

Current portion of long-term debt
2,754

 
2,743

Trade payables
4,326

 
4,449

Accrued marketing
474

 
680

Income taxes payable
88

 
152

Interest payable
404

 
419

Other current liabilities
1,011

 
1,229

Total current liabilities
9,091

 
10,132

Long-term debt
31,380

 
28,333

Deferred income taxes
14,230

 
14,076

Accrued postemployment costs
394

 
427

Other liabilities
929

 
1,017

TOTAL LIABILITIES
56,024

 
53,985

Commitments and Contingencies (Note 14)

 

Redeemable noncontrolling interest
7

 
6

Equity:
 
 
 
Common stock, $0.01 par value (5,000 shares authorized; 1,222 shares issued and 1,219 shares outstanding at June 30, 2018; 1,221 shares issued and 1,219 shares outstanding at December 30, 2017)
12

 
12

Additional paid-in capital
58,766

 
58,711

Retained earnings
8,710

 
8,589

Accumulated other comprehensive income/(losses)
(1,557
)
 
(1,054
)
Treasury stock, at cost (3 shares at June 30, 2018 and 2 shares at December 30, 2017)
(254
)
 
(224
)
Total shareholders' equity
65,677

 
66,034

Noncontrolling interest
188

 
207

TOTAL EQUITY
65,865

 
66,241

TOTAL LIABILITIES AND EQUITY
$
121,896

 
$
120,232


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
 
Accumulated Other Comprehensive Income/(Losses)
 
Treasury Stock
 
Noncontrolling Interest
 
Total Equity
Balance at December 30, 2017
12

 
58,711

 
8,589

 
(1,054
)
 
(224
)
 
207

 
66,241

Net income/(loss) excluding redeemable noncontrolling interest

 

 
1,749

 

 

 
5

 
1,754

Other comprehensive income/(loss) excluding redeemable noncontrolling interest

 

 

 
(503
)
 

 
(11
)
 
(514
)
Dividends declared-common stock

 

 
(1,524
)
 

 

 

 
(1,524
)
Cumulative effect of accounting standards adopted in the period

 

 
(95
)
 

 

 

 
(95
)
Exercise of stock options, issuance of other stock awards, and other

 
55

 
(9
)
 

 
(30
)
 
(13
)
 
3

Balance at June 30, 2018
$
12

 
$
58,766

 
$
8,710

 
$
(1,557
)
 
$
(254
)
 
$
188

 
$
65,865


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 Six Months Ended
 
June 30,
2018
 
July 1,
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income/(loss)
$
1,748

 
$
2,051

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

Depreciation and amortization
476

 
517

Amortization of postretirement benefit plans prior service costs/(credits)
(183
)
 
(171
)
Equity award compensation expense
27

 
24

Deferred income tax provision/(benefit)
58

 
269

Pension contributions
(42
)
 
(17
)
Impairment losses
265

 
48

Nonmonetary currency devaluation
67

 
33

Other items, net
41

 
(104
)
Changes in current assets and liabilities:
 
 
 
Trade receivables
(2,001
)
 
(1,598
)
Inventories
(440
)
 
(431
)
Accounts payable
143

 
84

Other current assets
(66
)
 
(121
)
Other current liabilities
136

 
(762
)
Net cash provided by/(used for) operating activities
229

 
(178
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Cash receipts on sold receivables
1,221

 
1,069

Capital expenditures
(438
)
 
(690
)
Payments to acquire business, net of cash acquired
(215
)
 

Other investing activities, net
11

 
44

Net cash provided by/(used for) investing activities
579

 
423

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayments of long-term debt
(25
)
 
(2,032
)
Proceeds from issuance of long-term debt
2,990

 

Proceeds from issuance of commercial paper
1,525

 
4,213

Repayments of commercial paper
(1,950
)
 
(3,777
)
Dividends paid-common stock
(1,659
)
 
(1,434
)
Other financing activities, net
(3
)
 
19

Net cash provided by/(used for) financing activities
878

 
(3,011
)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
(80
)
 
29

Cash, cash equivalents, and restricted cash
 
 
 
Net increase/(decrease)
1,606

 
(2,737
)
Balance at beginning of period
1,769

 
4,255

Balance at end of period
$
3,375

 
$
1,518

 
 
 
 
NON-CASH INVESTING ACTIVITIES:
 
 
 
Beneficial interest obtained in exchange for securitized trade receivables
$
899

 
$
1,407


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 fairly state our results for the periods presented.
The condensed consolidated balance sheet data at December 30, 2017 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 30, 2017. The results for interim periods are not necessarily indicative of future or annual results.
New Accounting Pronouncements
Accounting Standards Adopted in the Current Year:
In March 2017, the Financial Accounting Standards Board (the “FASB”) issued accounting standards update (“ASU”) 2017-07 related to the presentation of net periodic benefit cost (pension and postretirement cost). This ASU became 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 is 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. In the first quarter of 2018, we adopted this ASU using the practical expedient described above. The impact of retrospectively adopting this ASU on our historical statement of income is included in the table below. There was no associated impact to our condensed consolidated balance sheet at December 30, 2017 or our condensed consolidated statement of cash flows for the six months ended July 1, 2017.
In May 2014, the FASB issued ASU 2014-09, which superseded previously existing revenue recognition guidance. Under this ASU, companies must 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 to which the company expects to be entitled in exchange for those goods or services. 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. The ASU also provides for certain practical expedients, including the option to expense as incurred the incremental costs of obtaining a contract, if the contract period is for one year or less. This ASU was effective beginning in the first quarter of our fiscal year 2018. We adopted this ASU in the first quarter of 2018 using the full retrospective method and the practical expedient described above. Upon adoption, we made the following policy elections: (i) we account for shipping and handling costs as contract fulfillment costs, and (ii) we exclude taxes imposed on and collected from customers in revenue producing transactions (e.g., sales, use, and value added taxes) from the transaction price. The impact of adopting this guidance was immaterial to our financial statements and related disclosures.
While the impact of the adoption of ASU 2014-09 was immaterial, at the same time we retrospectively corrected immaterial misclassifications in our statements of income principally related to customer incentive program expenses. The impact on our statement of income for the three months ended July 1, 2017 was a decrease to net sales of $40 million, a decrease to cost of products sold of $38 million, and a decrease to selling, general and administrative expenses (“SG&A”) of $2 million. The impact on our statement of income for the six months ended July 1, 2017 was a decrease to net sales of $80 million, a decrease to cost of products sold of $76 million, and a decrease to SG&A of $4 million. These impacts are included in the table below. There was no associated impact to our condensed consolidated balance sheet at December 30, 2017 or our condensed consolidated statement of cash flows for the six months ended July 1, 2017.

6


The impacts of these ASUs and reclassifications on our historical statements of income were as follows (in millions):
 
For the Three Months Ended
 
For the Six Months Ended
 
July 1, 2017
 
July 1, 2017
 
As Reported
 
Adjustment
 
As Adjusted
 
As Reported
 
Adjustment
 
As Adjusted
Net sales
$
6,677

 
$
(40
)
 
$
6,637

 
$
13,041

 
$
(80
)
 
$
12,961

Cost of products sold
3,996

 
208

 
4,204

 
8,059

 
270

 
8,329

Gross profit
2,681

 
(248
)
 
2,433

 
4,982

 
(350
)
 
4,632

Selling, general and administrative expenses
760

 
29

 
789

 
1,510

 
45

 
1,555

Operating income
1,921

 
(277
)
 
1,644

 
3,472

 
(395
)
 
3,077

Other expense/(income), net
24

 
(277
)
 
(253
)
 
12

 
(395
)
 
(383
)
Income/(loss) before income taxes
1,590

 

 
1,590

 
2,840

 

 
2,840

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 became effective beginning in the first quarter of our fiscal year 2018. We adopted this new guidance on a modified retrospective basis through a cumulative-effect adjustment of $95 million to decrease retained earnings in the first quarter of 2018.
In January 2017, the FASB issued ASU 2017-01 clarifying the definition of a business used in determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU provides a screen for entities to determine if an integrated set of assets and activities (“set”) is not a business. If substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. If this screen is not met, the entity then determines if the set meets the minimum requirement of a business. For a set to be a business, it must include an input and a substantive process which together significantly contribute to the ability to create outputs. This ASU became effective beginning in the first quarter of our fiscal year 2018. We adopted this ASU on a prospective basis. The adoption of this ASU did not impact our financial statements or related disclosures.
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. We early adopted this guidance on a prospective basis as of April 1, 2018 (our annual impairment testing date in the second quarter of 2018). As a result of adopting this ASU, we did not perform Step 2 while completing our impairment testing.
Accounting Standards Not Yet Adopted:
In February 2016, the FASB issued ASU 2016-02 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 updated guidance requires lessees to reflect most leases on their balance sheets as assets and obligations. The ASU also provides for certain practical expedients, which we are considering for adoption. This includes ASU 2018-01, which provides a practical expedient that allows companies to exclude existing or expired land easements from the lease assessment (though new land easements entered into after adoption must be assessed). This ASU will be effective beginning in the first quarter of our fiscal year 2019. Early adoption is permitted. The guidance must be adopted using a modified retrospective transition. We are currently evaluating the impact this ASU will have on our financial statements and related disclosures. We have completed our scoping reviews, identified our significant leases by geography and by asset type, and made progress in developing accounting policies and policy elections upon adoption of the standard. We have also developed a lease data extraction strategy and commenced data extraction efforts. Furthermore, we have identified an accounting system to support the future state leasing process and have started to develop our future state process design as part of the overall system implementation. 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.

7


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;
Requires us to present excluded components related to cash flow hedges in the same income statement line item as the hedged item;
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. Early adoption is permitted, including in an interim period. We currently expect to adopt this guidance in the third quarter of 2018. Upon adoption, we expect to record an immaterial cumulative effect adjustment to retained earnings as of the beginning of our fiscal year 2018.
In February 2018, the FASB issued ASU 2018-02 related to reclassifying tax effects stranded in accumulated other comprehensive income because of the Tax Cuts and Jobs Act enacted on December 22, 2017 (“U.S. Tax Reform”). U.S. Tax Reform reduced the U.S. federal corporate tax rate from 35.0% to 21.0%. Accounting Standards Codification Topic 740, Income Taxes, (“ASC 740”) requires the remeasurement of deferred tax assets and liabilities as a result of such changes in tax laws or rates to be presented in net income from continuing operations. However, the related tax effects of such deferred tax assets and liabilities may have been originally recorded in other comprehensive income. This ASU allows companies to reclassify such stranded tax effects from accumulated other comprehensive income to retained earnings. This reclassification adjustment is optional, and if elected, may be applied either to the period of adoption or retrospectively to the period(s) impacted by U.S. Tax Reform. Additionally, this ASU requires companies to disclose the policy election for stranded tax effects as well as the general accounting policy for releasing income tax effects from accumulated other comprehensive income. This guidance is effective in the first quarter of 2019. Early adoption is permitted, including in an interim period. We are currently evaluating the impact this ASU will have on our financial statements and related disclosures, including the timing of adoption and the application method.
Significant Accounting Policies
The following significant accounting policies were updated in the first quarter of 2018 to reflect changes upon adoption of ASU 2014-09 and ASU 2017-07. There were no other changes to our accounting policies from those disclosed in our Annual Report on Form 10-K for the year ended December 30, 2017.
Revenue Recognition:
Our revenues are primarily derived from customer orders for the purchase of our products. We recognize revenues as performance obligations are fulfilled when control passes to our customers. We record revenues net of variable consideration including consumer incentives and performance obligations related to trade promotions, excluding taxes, and including all shipping and handling charges billed to customers (accounting for shipping and handling charges that occur after the transfer of control as fulfillment costs). We also record a refund liability for estimated product returns and customer allowances as reductions to revenues within the same period that the revenue is recognized. We base these estimates principally on historical and current period experience factors. We recognize costs paid to third party brokers to obtain contracts as expenses as our contracts are generally less than one year.
Advertising, Consumer Incentives, and Trade Promotions:
We promote our products with advertising, consumer incentives, and performance obligations related to trade promotions. Consumer incentives and trade promotions include, but are not limited to, discounts, coupons, rebates, performance-based in-store display activities, and volume-based incentives. Variable consideration related to consumer incentive and trade promotion activities is recorded as a reduction to revenues based on amounts estimated as being due to customers and consumers at the end of a period. We base these estimates principally on historical utilization, redemption rates, or current period experience factors. We review and adjust these estimates each quarter based on actual experience and other information.

8


Postemployment Benefit Plans:
We maintain various retirement plans for the majority of our employees. These include pension benefits, postretirement health care benefits, and defined contribution benefits. The cost of these plans is charged to expense over the working life of the covered employees. We generally amortize net actuarial gains or losses in future periods within other expense/(income), net.
Note 2. Acquisition and Divestiture
Acquisition
On March 9, 2018 (the “Acquisition Date”), we acquired all of the outstanding equity interests in Cerebos Pacific Limited (“Cerebos”) (the “Acquisition”), an Australian and New Zealand food and beverage company with several iconic local brands. The Cerebos business manufactures, markets, and sells food and beverage products, including gravies, sauces, instant coffee, salt, herbs and spices, and tea. Cerebos is included in our condensed consolidated financial statements as of the Acquisition Date. We elected to include the results of Cerebos from March 9 to March 31, 2018 in our condensed consolidated statement of income for the three months ended June 30, 2018. These results were insignificant. The preliminary opening balance sheet of Cerebos was included in our condensed consolidated balance sheet at June 30, 2018. We have not included unaudited pro forma results, prepared in accordance with ASC 805, as if Cerebos had been acquired as of January 1, 2018, as it would not yield materially different results.
The Acquisition was accounted for under the acquisition method of accounting for business combinations. The total consideration paid for Cerebos was approximately $238 million. We utilized estimated fair values at the Acquisition Date to allocate the total consideration exchanged to the net tangible and intangible assets acquired and liabilities assumed. The purchase price allocation for the Acquisition is preliminary and subject to adjustments.
The fair value estimates of the assets acquired are subject to adjustment during the measurement period (up to one year from the Acquisition Date). The primary areas of accounting for the Acquisition that are not yet finalized relate to the fair value of certain tangible and intangible assets acquired, residual goodwill, and any related tax impact. The fair values of these net assets acquired are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. While we believe that such preliminary estimates provide a reasonable basis for estimating the fair value of assets acquired and liabilities assumed, we will evaluate any necessary information prior to finalization of the fair value. During the measurement period, we will adjust preliminary valuations assigned to assets and liabilities if new information is obtained about facts and circumstances that existed as of the Acquisition Date, if any, that, if known, would have resulted in revised values for these items as of that date. The impact of all changes, if any, that do not qualify as measurement period adjustments will be included in current period earnings.
The preliminary purchase price allocation to assets acquired and liabilities assumed in the Acquisition was (in millions):
Cash
$
23

Other current assets
65

Property, plant and equipment, net
75

Identifiable intangible assets
100

Trade and other payables
(41
)
Other non-current liabilities
(3
)
Net assets acquired
219

Goodwill on acquisition
19

Total consideration
$
238

In the second quarter of 2018, we made insignificant measurement period adjustments, which are reflected in the preliminary purchase price allocation table above. We made these measurement period adjustments to reflect facts and circumstances that existed as of the Acquisition Date and did not result from intervening events subsequent to such date.
The Acquisition preliminarily resulted in $19 million of non tax deductible goodwill relating principally to planned expansion of Cerebos brands into new categories and markets. Goodwill has been allocated to our segments as shown in Note 6, Goodwill and Intangible Assets.

9


The preliminary purchase price allocation to identifiable intangible assets acquired was:
 
Fair Value
(in millions of dollars)
 
Weighted Average Life
(in years)
Definite-lived trademarks
$
87

 
22
Customer-related assets
13

 
12
Total
$
100

 
 
We valued trademarks using the relief from royalty method and customer-related assets using the distributor method. Some of the more significant assumptions inherent in developing the valuations included the estimated annual net cash flows for each definite-lived intangible asset (including net sales, cost of products sold, selling and marketing costs, and working capital/contributory asset charges), the discount rate that appropriately reflects the risk inherent in each future cash flow stream, the assessment of each asset’s life cycle, and competitive trends, as well as other factors. We determined the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management plans, and market comparables.
We used carrying values as of the Acquisition Date to value trade receivables and payables, as well as certain other current and non-current assets and liabilities, as we determined that they represented the fair value of those items at the Acquisition Date.
We valued finished goods and work-in-process inventory using a net realizable value approach. Raw materials and packaging inventory was valued using the replacement cost approach.
We valued property, plant and equipment using a combination of the income approach, the market approach and the cost approach, which is based on current replacement and/or reproduction cost of the asset as new, less depreciation attributable to physical, functional, and economic factors.
We incurred deal costs of $7 million for the three months and $16 million for the six months ended June 30, 2018 related to the Acquisition.
Divestiture
On May 31, 2018, we sold our 50.1% interest in our South African subsidiary to our minority interest partner. The transaction included proceeds of $18 million, which are included in other investing activities, net on the condensed consolidated statement of cash flows for the six months ended June 30, 2018. We recorded a pre-tax loss on sale of business of approximately $15 million. The pre-tax loss is included in SG&A on the condensed consolidated statements of income for the three and six months ended June 30, 2018.
Note 3. 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, costs to exit facilities, and costs associated with restructuring benefit plans.
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.

10


Integration Program:
In July 2015, 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. As of December 30, 2017, we had substantially completed our Integration Program. Approximately 60% of total Integration Program costs were reflected in cost of products sold and approximately 60% were cash expenditures.
Overall, as part of the Integration Program, we closed net six factories, consolidated our distribution network, and eliminated 4,900 positions. The Integration Program liability at June 30, 2018 related primarily to lease terminations in the U.S. and Canada and the elimination of general salaried positions in Canada.
As of June 30, 2018, we have incurred cumulative costs of $2,135 million, including $22 million for the three months and $80 million for the six months ended June 30, 2018 and gains of $49 million for the three months and expenses of $78 million for the six months ended July 1, 2017. The $2,135 million of cumulative costs included $542 million of severance and employee benefit costs, $883 million of non-cash asset-related costs, $601 million of other implementation costs, and $109 million of other exit costs. The related amounts incurred during the three months ended June 30, 2018 were $3 million of severance and employee benefit costs, $5 million of non-cash asset-related costs, $13 million of other implementation costs, and $1 million of other exit costs. The related amounts incurred during the six months ended June 30, 2018 were $3 million of severance and employee benefit costs, $25 million of non-cash asset-related costs, $51 million of other implementation costs, and $1 million of other exit costs.
We expect to incur additional Integration Program costs of approximately $10 million, primarily in the third quarter of 2018.
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 30, 2017
$
24

 
$
22

 
$
46

Charges
3

 
1

 
4

Cash payments
(7
)
 
(6
)
 
(13
)
Non-cash utilization
(9
)
 
(6
)
 
(15
)
Balance at June 30, 2018
$
11

 
$
11

 
$
22

(a) Other exit costs primarily consist of lease and contract terminations.
We expect the liability for severance and employee benefit costs as of June 30, 2018 to be paid by 2019. The liability for other exit costs primarily relates to lease obligations. The cash impact of these obligations will continue for the duration of the lease terms, which expire between 2019 and 2026.
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, factory closure and consolidation, and benefit plan restructuring. Related to these programs, we expect to eliminate approximately 1,400 positions, 600 of whom left the Company during the six months ended June 30, 2018. These programs resulted in expenses of $167 million during the six months ended June 30, 2018, including $38 million of severance and employee benefit costs, $1 million of non-cash asset-related costs, $127 million of other implementation costs, and $1 million of other exit costs. Other restructuring expenses during the three months ended June 30, 2018 were $135 million, including $17 million of severance and employee benefit costs, $1 million of non-cash asset-related costs, $116 million of other implementation costs, and $1 million of other exit costs. Other restructuring program expenses totaled $43 million for the three months and $64 million for the six months ended July 1, 2017.

11


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 30, 2017
$
16

 
$
25

 
$
41

Charges
38

 
1

 
39

Cash payments
(16
)
 

 
(16
)
Non-cash utilization
3

 

 
3

Balance at June 30, 2018
$
41

 
$
26

 
$
67

(a) Other exit costs primarily consist of lease and contract terminations.
We expect a substantial portion of the liability for severance and employee benefit costs as of June 30, 2018 to be paid in 2018. The liability for other exit costs primarily relates to lease obligations. The cash impact of these obligations will continue for the duration of the lease terms, which expire between 2018 and 2026.
Total Integration and Restructuring:
Total expenses related to the Integration Program and restructuring activities, by income statement caption, were (in millions):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Severance and employee benefit costs - COGS
$
9

 
$
6

 
$
25

 
$
18

Severance and employee benefit costs - SG&A
5

 
34

 
10

 
53

Severance and employee benefit costs - Other expense/(income), net
6

 
(160
)
 
6

 
(147
)
Asset-related costs - COGS
5

 
25

 
25

 
100

Asset-related costs - SG&A
1

 
6

 
1

 
13

Other costs - COGS
65

 
52

 
107

 
61

Other costs - SG&A
8

 
31

 
15

 
44

Other costs - Other expense/(income), net
58

 

 
58

 

 
$
157

 
$
(6
)
 
$
247

 
$
142

We do not include Integration Program and restructuring expenses within Segment Adjusted EBITDA (as defined in Note 16, 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 Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
United States
$
69

 
$
(65
)
 
$
121

 
$
43

Canada
63

 
14

 
66

 
24

EMEA
7

 
26

 
28

 
40

Rest of World
9

 
10

 
9

 
10

General corporate expenses
9

 
9

 
23

 
25

 
$
157

 
$
(6
)
 
$
247

 
$
142

In the first quarter of 2018, we reorganized our segment structure to move our Middle East and Africa businesses from the Rest of World segment to the Europe, Middle East, and Africa (“EMEA”) reportable segment. We have reflected this change in all historical periods presented. This change did not have a material impact on our current or any prior period results. See Note 16, Segment Reporting, for additional information.

12


Note 4. 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):
 
June 30,
2018
 
December 30, 2017
Cash and cash equivalents
$
3,369

 
$
1,629

Restricted cash included in other assets (current)
6

 
140

Cash, cash equivalents, and restricted cash
$
3,375

 
$
1,769

Note 5. Inventories
Inventories consisted of the following (in millions):
 
June 30, 2018
 
December 30, 2017
Packaging and ingredients
$
633

 
$
560

Work in process
449

 
439

Finished product
2,079

 
1,816

Inventories
$
3,161

 
$
2,815

Note 6. Goodwill and Intangible Assets
Goodwill:
Changes in the carrying amount of goodwill, by segment, were (in millions):
 
United States
 
Canada
 
EMEA
 
Rest of World
 
Total
Balance at December 30, 2017
$
33,700

 
$
5,246

 
$
3,238

 
$
2,640

 
$
44,824

Impairment losses

 

 

 
(164
)
 
(164
)
Acquisition

 

 

 
19

 
19

Translation adjustments and other

 
(221
)
 
(86
)
 
(102
)
 
(409
)
Balance at June 30, 2018
$
33,700

 
$
5,025

 
$
3,152

 
$
2,393

 
$
44,270

In the first quarter of 2018, we reorganized our segment structure to move our Middle East and Africa businesses from the Rest of World segment to the EMEA reportable segment. We have reflected this change in all historical periods presented. Accordingly, the segment goodwill balances at December 30, 2017 reflect an increase of $179 million in EMEA and a corresponding decrease in Rest of World. This change did not have a material impact on our current or any prior period results. See Note 16, Segment Reporting, for additional information.
See Note 2, Acquisition and Divestiture, for additional information related to our acquisition of Cerebos.
Our goodwill balance consists of 20 reporting units and had an aggregate carrying value of $44.3 billion as of June 30, 2018. We test goodwill for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2018 annual impairment test as of April 1, 2018. As a result of our 2018 annual impairment test, we recognized a non-cash impairment loss of $164 million in SG&A related to our Australia and New Zealand reporting unit. This impairment loss was primarily due to margin declines in the region. The goodwill carrying value of this reporting unit was $509 million prior to its impairment. Additionally, we noted that four of our 20 reporting units each had excess fair value over its carrying value of less than 10%. As of the impairment test date, the goodwill carrying values associated with these reporting units were $4.7 billion for Canada Retail, $424 million for Latin America Exports, $407 million for Northeast Asia, and $326 million for Southeast Asia.
We generally utilize the discounted cash flow method under the income approach to estimate the fair value of our reporting units. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each reporting unit (including net sales, cost of products sold, SG&A, working capital, and capital expenditures), income tax rates, and a discount rate that appropriately reflects the risk inherent in each future cash flow stream. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management plans, and guideline companies.

13


Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry and economic conditions. If our current assumptions and estimates, including future annual net cash flows, income tax rates, and discount rates, 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. Additionally, as a majority of our goodwill was recorded in connection with business combinations that occurred in 2015 and 2013, representing fair values as of the respective transaction dates, those amounts are more susceptible to an impairment risk if business operating results or macroeconomic conditions deteriorate.
Accumulated impairment losses to goodwill were $164 million at June 30, 2018. There were no accumulated impairment losses to goodwill at December 30, 2017.
Indefinite-lived intangible assets:
Changes in the carrying amount of indefinite-lived intangible assets, which primarily consisted of trademarks, were (in millions):
Balance at December 30, 2017
$
53,655

Impairment losses
(101
)
Translation adjustments
(175
)
Balance at June 30, 2018
$
53,379

Our indefinite-lived intangible assets primarily consist of a large number of individual brands and had an aggregate carrying value of $53.4 billion as of June 30, 2018. We test indefinite-lived intangible assets for impairment at least annually in the second quarter or when a triggering event occurs. We performed our 2018 annual impairment test as of April 1, 2018. As a result of our 2018 annual impairment test, we recognized a non-cash impairment loss of $101 million in SG&A in the second quarter of 2018. This impairment loss was due to net sales and margin declines related to the Quero brand in Brazil. Additionally, as of April 1, 2018, two brands (ABC and Smart Ones) each had excess fair value over its carrying value of less than 10%. These brands had an aggregate carrying value of $665 million as of April 1, 2018.
As a result of our 2017 annual impairment testing, we recognized a non-cash impairment loss of $48 million in SG&A in the second quarter of 2017. This loss was due to continued declines in nutritional beverages in India. The loss was recorded in our EMEA segment as the related trademark is owned by our Italian subsidiary.
We generally utilize the excess earnings method under the income approach to estimate the fair value of certain of our largest brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net cash flows for each brand (including net sales, cost of products sold, and SG&A), contributory asset charges, income tax considerations, a discount rate that reflects the level of risk associated with the future earnings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management plans, and guideline companies.
We generally utilize the relief from royalty method under the income approach to estimate the fair value of our remaining brands. Some of the more significant assumptions inherent in estimating the fair values include the estimated future annual net sales for each brand, royalty rates (as a percentage of revenue that would hypothetically be charged by a licensor of the brand to an unrelated licensee), income tax considerations, a discount rate that reflects the level of risk associated with the future cost savings attributable to the brand, and management’s intent to invest in the brand indefinitely. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated product category growth rates, management plans, and guideline companies.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual indefinite-lived intangible assets requires us to make assumptions and estimates regarding our future plans, as well as industry and economic conditions. If our current assumptions and estimates, including future annual net cash flows, royalty rates, contributory asset charges, income tax considerations, and discount rates, 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. Additionally, as a majority of our indefinite-lived intangible assets were recorded in connection with business combinations that occurred in 2015 and 2013, representing fair values as of the respective transaction dates, those amounts are more susceptible to an impairment risk if business operating results or macroeconomic conditions deteriorate.

14


Definite-lived intangible assets:
Definite-lived intangible assets were (in millions):
 
June 30, 2018
 
December 30, 2017
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
Trademarks
$
2,454

 
$
(341
)
 
$
2,113

 
$
2,386

 
$
(288
)
 
$
2,098

Customer-related assets
4,215

 
(621
)
 
3,594

 
4,231

 
(544
)
 
3,687

Other
19

 
(4
)
 
15

 
14

 
(5
)
 
9

 
$
6,688

 
$
(966
)
 
$
5,722

 
$
6,631

 
$
(837
)
 
$
5,794

Amortization expense for definite-lived intangible assets was $70 million for the three months and $139 million for the six months ended June 30, 2018 and $77 million for the three months and $144 million for the six months ended July 1, 2017. Additionally, we preliminarily recorded $87 million of trademarks and $13 million of customer-related assets in the first quarter of 2018 as part of the Cerebos acquisition. Aside from amortization expense and preliminary purchase accounting additions, the changes in definite-lived intangible assets from December 30, 2017 to June 30, 2018 primarily reflect the impact of foreign currency. We estimate that amortization expense related to definite-lived intangible assets will be approximately $280 million for each of the next five years.
Note 7. 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 27.9% for the three months ended June 30, 2018 compared to 27.1% for the three months ended July 1, 2017. The increase in our effective tax rate was mostly driven by the unfavorable impact of current year net discrete items, in particular the revaluation of our deferred tax balances due to changes in state tax laws following U.S. Tax Reform, as well as the non-deductible impairment of goodwill. This negative impact was mostly offset by the favorable impact of U.S. Tax Reform, primarily related to the lower federal corporate tax rate, partially offset by tax associated with certain provisions of U.S. Tax Reform such as the federal tax on GILTI (defined below). Additionally, in the prior year, we had favorability from net discrete items, primarily related to reversals of uncertain tax position reserves in the U.S. and certain state jurisdictions.
Our effective tax rate was 24.0% for the six months ended June 30, 2018 compared to 27.8% for the six months ended July 1, 2017The decrease in our effective tax rate was mostly driven by the favorable impact of U.S. Tax Reform, primarily related to the lower federal corporate tax rate. This favorability was partially offset by tax associated with certain provisions of U.S. Tax Reform such as the federal tax on GILTI (defined below) and the unfavorable impact of current year net discrete items, in particular the revaluation of our deferred tax balances due to changes in state tax laws following U.S. Tax Reform, as well as the non-deductible impairment of goodwill. Additionally, in the prior year, we had favorability from net discrete items, primarily related to reversals of uncertain tax position reserves in the U.S., foreign, and certain state jurisdictions.
U.S. Tax Reform legislation enacted by the federal government on December 22, 2017 significantly changed U.S. tax laws by, among other things, lowering the federal corporate tax rate from 35.0% to 21.0%, effective January 1, 2018, and imposing a one-time toll charge on deemed repatriated earnings of foreign subsidiaries as of December 30, 2017. Other changes from U.S. Tax Reform include changes to bonus depreciation, the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income provisions (“GILTI”), the base erosion anti-abuse tax (“BEAT”), and a deduction for foreign-derived intangible income (“FDII”).
Staff Accounting Bulletin No. 118 (“SAB 118”) issued by the SEC in December 2017 provides us with up to one year to finalize accounting for the impacts of U.S. Tax Reform. While the initial accounting for U.S Tax Reform impacts is incomplete, we may include provisional amounts when reasonable estimates can be made. As of December 30, 2017, we had made reasonable estimates of our deferred income tax benefit related to the corporate rate change, the toll charge, and other tax expenses, including a change in our indefinite reinvestment assertion related to historic earnings of foreign subsidiaries as of December 30, 2017. In the first quarter of 2018, we recorded a measurement period adjustment to reduce income tax expense and reduce deferred tax liabilities each by approximately $20 million. In the second quarter of 2018, we recorded an insignificant measurement period adjustment. We did not record any other measurement period adjustments to our provisional U.S. Tax Reform amounts during the six months ended June 30, 2018.

15


The ultimate impacts of U.S. Tax Reform may differ from our provisional amounts due to gathering additional information to more precisely compute the amount of tax, changes in interpretations and assumptions, additional regulatory guidance that may be issued, and actions we may take. We expect to revise our U.S. Tax Reform impact estimates as we refine our analysis of the new rules and as new guidance is issued. We expect to finalize accounting for the impacts of U.S. Tax Reform when the 2017 U.S. corporate income tax return is filed in 2018.
We have undistributed historic earnings in foreign subsidiaries which are currently not considered to be indefinitely reinvested. We have recorded a reasonable estimate of deferred taxes of $96 million as of June 30, 2018 to reflect local country withholding taxes that will be owed when this cash is distributed in the future. Additionally, we consider the unremitted current year earnings of certain international subsidiaries that impose local country taxes on dividends to be indefinitely reinvested. For those undistributed earnings considered to be indefinitely reinvested, our intent is to reinvest these funds in our international operations and our current plans do not demonstrate a need to repatriate the accumulated earnings to fund our U.S. cash requirements.
See Note 8, Income Taxes, to our consolidated financial statements for the year ended December 30, 2017 in our Annual Report on Form 10-K for additional information related to U.S. Tax Reform impacts.
Note 8. Employees’ Stock Incentive Plans
Our annual equity award grants and vesting occurred in the first quarter of 2018. Other off-cycle equity grants and vesting 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 30, 2017
19,289,564

 
$
41.63

Granted
1,420,250

 
66.89

Forfeited
(724,506
)
 
59.16

Exercised
(940,978
)
 
30.14

Outstanding at June 30, 2018
19,044,330

 
43.41

The aggregate intrinsic value of stock options exercised during the period was $35 million for the six months ended June 30, 2018.
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 30, 2017
1,284,262

 
$
81.91

Granted
1,359,491

 
58.63

Forfeited
(137,660
)
 
78.90

Vested
(115,561
)
 
73.19

Outstanding at June 30, 2018
2,390,532

 
69.27

The aggregate fair value of RSUs that vested during the period was $8 million for the six months ended June 30, 2018.

16


Performance Share Units:
Our performance share unit (“PSU”) activity and related information was:
 
Number of Units
 
Weighted Average Grant Date Fair Value
(per share)
Outstanding at December 30, 2017
815,383

 
$
70.16

Granted
2,595,333

 
56.82

Forfeited
(187,625
)
 
63.58

Outstanding at June 30, 2018
3,223,091

 
59.80

Note 9. Postemployment Benefits
We capitalize a portion of net pension and postretirement cost/(benefit) into inventory based on our production activities. The amounts capitalized into inventory as of June 30, 2018 and July 1, 2017 are included in the net pension and postretirement cost/(benefit) tables below. Beginning January 1, 2018, only the service cost component of net pension and postretirement cost/(benefit) is capitalized into inventory. As part of the adoption of ASU 2017-07 in the first quarter of 2018, we recognized a one-time favorable credit of $42 million within cost of products sold related to amounts that were previously capitalized into inventory. Included in this credit was $28 million related to prior service credits that were previously capitalized to inventory.
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 Six Months Ended
 
U.S. Plans
 
Non-U.S. Plans
 
U.S. Plans
 
Non-U.S. Plans
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Service cost
$
3

 
$
2

 
$
5

 
$
4

 
$
5

 
$
5

 
$
10

 
$
8

Interest cost
38

 
46

 
17

 
16

 
77

 
91

 
36

 
32

Expected return on plan assets
(64
)
 
(66
)
 
(44
)
 
(43
)
 
(127
)
 
(131
)
 
(92
)
 
(86
)
Amortization of unrecognized losses/(gains)

 

 

 
1

 

 

 
1

 
1

Settlements
(2
)
 

 
58

 

 
(2
)
 

 
58

 

Curtailments

 

 
(1
)
 

 

 

 
(1
)
 

Special/contractual termination benefits

 
6

 
5

 
2

 

 
13

 
6

 
8

Other

 

 

 

 

 
2

 

 
(9
)
Net pension cost/(benefit)
$
(25
)
 
$
(12
)
 
$
40

 
$
(20
)
 
$
(47
)
 
$
(20
)
 
$
18

 
$
(46
)
We present all non-service cost components of net pension cost/(benefit) within other expense/(income), net on our condensed consolidated statements of income.
Employer Contributions:
During the six months ended June 30, 2018, we contributed $42 million to our non-U.S. pension plans. We did not contribute to our U.S. pension plans. Based on our contribution strategy, we plan to make further contributions of approximately $10 million to our non-U.S. pension plans during the remainder of 2018. We do not plan to make contributions to our U.S. pension plans in 2018. However, our actual contributions and plans may change due to many factors, including the timing of regulatory approval for the wind-up of a non-U.S. pension plan, 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.

17


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 Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Service cost
$
2

 
$
3

 
$
4

 
$
5

Interest cost
11

 
12

 
22

 
25

Expected return on plan assets
(13
)
 

 
(25
)
 

Amortization of prior service costs/(credits)
(78
)
 
(83
)
 
(156
)
 
(173
)
Curtailments

 
(168
)
 

 
(168
)
Net postretirement cost/(benefit)
$
(78
)
 
$
(236
)
 
$
(155
)
 
$
(311
)
We present all non-service cost components of net postretirement cost/(benefit) within other expense/(income), net on our condensed consolidated statements of income.
Employer Contributions:
During the six months ended June 30, 2018, we contributed $18 million to our postretirement benefit plans. Based on our contribution strategy, we plan to make further contributions of approximately $10 million to our postretirement benefit plans during the remainder of 2018. However, our actual contributions and plans may change due to many factors, including changes in tax, employee benefit, or other laws and regulations, tax deductibility, significant differences between expected and actual postretirement plan asset performance or interest rates, or other factors.
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 30, 2017 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 outstanding derivative instruments were (in millions):
 
June 30, 2018
 
December 30, 2017
Commodity contracts
$
480

 
$
272

Foreign exchange contracts
2,780

 
2,876

Cross-currency contracts
3,161

 
3,161


18


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 were (in millions):
 
June 30, 2018
 
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
$

 
$

 
$
48

 
$
5

 
$

 
$

 
$
48

 
$
5

Cross-currency contracts

 

 
431

 

 

 

 
431

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
8

 
16

 

 

 

 

 
8

 
16

Foreign exchange contracts

 

 
2

 
23

 

 

 
2

 
23

Cross-currency contracts

 

 
18

 

 

 

 
18

 

Total fair value
$
8

 
$
16

 
$
499

 
$
28

 
$

 
$

 
$
507

 
$
44

 
December 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
$

 
$

 
$
8

 
$
42

 
$

 
$

 
$
8

 
$
42

Cross-currency contracts

 

 
344

 

 

 

 
344

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
4

 
8

 

 

 

 

 
4

 
8

Foreign exchange contracts

 

 
17

 
3

 

 

 
17

 
3

Cross-currency contracts

 

 
19

 

 

 

 
19

 

Total fair value
$
4

 
$
8

 
$
388

 
$
45

 
$

 
$

 
$
392

 
$
53

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 $28 million at June 30, 2018 and $23 million at December 30, 2017. No material amounts of collateral were received or posted on our derivative assets and liabilities at June 30, 2018.
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 swaps, foreign exchange forwards and swaps, and cross-currency swaps. Commodity swaps 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 and swaps 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.

19


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 June 30, 2018, the principal amounts of foreign denominated debt designated as net investment hedges totaled €2,550 million and £400 million.
At June 30, 2018, 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 June 30, 2018, we had Chinese renminbi foreign exchange contracts with an aggregate USD notional amount of $205 million.
Hedge Coverage:
At June 30, 2018, 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 18 months.
At June 30, 2018, 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 18 months;
foreign exchange contracts for periods not exceeding the next eight months; and
cross-currency contracts for periods not exceeding the next 16 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 June 30, 2018 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 approximately $15 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.

20


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 Months Ended
 
June 30,
2018
 
July 1,
2017
 
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)
$

 
$
38

 
$

 
$

 
$

 
$
(32
)
 
$

 
$

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

 
13

 
107

 

 

 
(8
)
 
(66
)
 

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

 
$
51

 
$
107

 
$

 
$

 
$
(40
)
 
$
(66
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges reclassified to net income/(loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold (effective portion)
$

 
$
(4
)
 
$

 
$

 
$

 
$
4

 
$

 
$

Other expense/(income), net

 
13

 

 

 

 
(31
)
 

 

Interest expense

 

 

 
(1
)
 

 

 

 
(1
)
 

 
9

 

 
(1
)
 

 
(27
)
 

 
(1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) on derivatives recognized in cost of products sold
(10
)
 

 

 

 

 

 

 

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

 
(64
)
 

 

 

 
26

 
(1
)
 

 
(10
)
 
(64
)
 

 

 

 
26

 
(1
)
 

Total gains/(losses) recognized in statements of income
$
(10
)
 
$
(55
)
 
$

 
$
(1
)
 
$

 
$
(1
)
 
$
(1
)
 
$
(1
)

21


 
For the Six Months Ended
 
June 30,
2018
 
July 1,
2017
 
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)
$

 
$
63

 
$

 
$

 
$

 
$
(71
)
 
$

 
$

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

 
2

 
96

 

 

 
(12
)
 
(96
)
 

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

 
$
65

 
$
96

 
$

 
$

 
$
(83
)
 
$
(96
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges reclassified to net income/(loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold (effective portion)
$

 
$
(9
)
 
$

 
$

 
$

 
$
3

 
$

 
$

Other expense/(income), net

 
31

 

 

 

 
(46
)
 

 

Interest expense

 

 

 
(2
)
 

 

 

 
(2
)
 

 
22

 

 
(2
)
 

 
(43
)
 

 
(2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains/(losses) on derivatives recognized in cost of products sold
(15
)
 

 

 

 
(37
)
 

 

 

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

 
(44
)
 
(1
)
 

 

 
28

 
(2
)
 

 
(15
)
 
(44
)
 
(1
)
 

 
(37
)
 
28

 
(2
)
 

Total gains/(losses) recognized in statements of income
$
(15
)
 
$
(22
)
 
$
(1
)
 
$
(2
)
 
$
(37
)
 
$
(15
)
 
$
(2
)
 
$
(2
)
Related to our non-derivative, foreign denominated debt instruments designated as net investment hedges, we recognized pre-tax gains of $195 million for the three months and $92 million for the six months ended June 30, 2018 and pre-tax losses of $216 million for the three months and $260 million for the six months ended July 1, 2017. These amounts were recognized in other comprehensive income/(loss) for the periods then ended.

22


Note 11. 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 30, 2017
$
(1,587
)
 
$
549

 
$
(16
)
 
$
(1,054
)
Foreign currency translation adjustments
(660
)
 

 

 
(660
)
Net deferred gains/(losses) on net investment hedges
145