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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2019
OR
☐ 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 001-02217
COCA COLA CO
(Exact name of Registrant as specified in its charter)
|
| | | |
Delaware | | 58-0628465 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
One Coca-Cola Plaza | | |
Atlanta | Georgia | | 30313 |
(Address of principal executive offices) | | (Zip Code) |
Registrant's telephone number, including area code: (404) 676-2121
Securities registered pursuant to Section 12(b) of the Act:
|
| | |
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Common Stock, $0.25 Par Value | KO | New York Stock Exchange |
0.000% Notes Due 2021 | KO21B | New York Stock Exchange |
Floating Rate Notes Due 2021 | KO21C | New York Stock Exchange |
1.125% Notes Due 2022 | KO22 | New York Stock Exchange |
0.125% Notes Due 2022 | KO22B | New York Stock Exchange |
0.75% Notes Due 2023 | KO23B | New York Stock Exchange |
0.500% Notes Due 2024 | KO24 | New York Stock Exchange |
1.875% Notes Due 2026 | KO26 | New York Stock Exchange |
0.750% Notes Due 2026 | KO26C | New York Stock Exchange |
1.125% Notes Due 2027 | KO27 | New York Stock Exchange |
1.250% Notes Due 2031 | KO31 | New York Stock Exchange |
1.625% Notes Due 2035 | KO35 | New York Stock Exchange |
1.100% Notes Due 2036 | KO36 | New York Stock Exchange |
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 ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
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 | ☒ | | | Accelerated filer | ☐ |
Non-accelerated filer | ☐ | | | Smaller reporting company | ☐ |
Emerging growth company | ☐ | | | |
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. | ☐ |
Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. |
| | |
Class of Common Stock | | Shares Outstanding as of October 21, 2019 |
$0.25 Par Value | | 4,284,491,377 |
THE COCA-COLA COMPANY AND SUBSIDIARIES
Table of Contents
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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Item 1. | | |
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Item 1A. | | |
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Item 2. | | |
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Item 6. | | |
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FORWARD-LOOKING STATEMENTS
This report contains information that may constitute "forward-looking statements." Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "project," "will" and similar expressions identify forward-looking statements, which generally are not historical in nature. However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to volume growth, share of sales and earnings per share growth, and statements expressing general views about future operating results — are forward-looking statements. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in Part II, "Item 1A. Risk Factors" and elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2018, and those described from time to time in our future reports filed with the Securities and Exchange Commission.
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In millions except per share data)
|
| | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 27, 2019 |
| September 28, 2018 |
| | September 27, 2019 |
| September 28, 2018 |
|
Net Operating Revenues | $ | 9,507 |
| $ | 8,775 |
| | $ | 28,198 |
| $ | 26,494 |
|
Cost of goods sold | 3,767 |
| 3,346 |
| | 11,053 |
| 9,965 |
|
Gross Profit | 5,740 |
| 5,429 |
| | 17,145 |
| 16,529 |
|
Selling, general and administrative expenses | 3,116 |
| 2,660 |
| | 8,879 |
| 8,286 |
|
Other operating charges | 125 |
| 155 |
| | 344 |
| 916 |
|
Operating Income | 2,499 |
| 2,614 |
| | 7,922 |
| 7,327 |
|
Interest income | 153 |
| 171 |
| | 428 |
| 510 |
|
Interest expense | 230 |
| 214 |
| | 711 |
| 697 |
|
Equity income (loss) — net | 346 |
| 348 |
| | 808 |
| 813 |
|
Other income (loss) — net | 324 |
| (546 | ) | | (81 | ) | (693 | ) |
Income Before Income Taxes | 3,092 |
| 2,373 |
| | 8,366 |
| 7,260 |
|
Income taxes | 503 |
| 555 |
| | 1,446 |
| 1,711 |
|
Consolidated Net Income | 2,589 |
| 1,818 |
| | 6,920 |
| 5,549 |
|
Less: Net income (loss) attributable to noncontrolling interests | (4 | ) | (62 | ) | | 42 |
| (15 | ) |
Net Income Attributable to Shareowners of The Coca-Cola Company | $ | 2,593 |
| $ | 1,880 |
| | $ | 6,878 |
| $ | 5,564 |
|
Basic Net Income Per Share1 | $ | 0.61 |
| $ | 0.44 |
| | $ | 1.61 |
| $ | 1.31 |
|
Diluted Net Income Per Share1 | $ | 0.60 |
| $ | 0.44 |
| | $ | 1.60 |
| $ | 1.29 |
|
Average Shares Outstanding | 4,280 |
| 4,255 |
| | 4,273 |
| 4,258 |
|
Effect of dilutive securities | 41 |
| 40 |
| | 38 |
| 39 |
|
Average Shares Outstanding Assuming Dilution | 4,321 |
| 4,295 |
| | 4,311 |
| 4,297 |
|
1 Calculated based on net income attributable to shareowners of The Coca-Cola Company.
Refer to Notes to Condensed Consolidated Financial Statements.
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(In millions)
|
| | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 27, 2019 |
| September 28, 2018 |
| | September 27, 2019 |
| September 28, 2018 |
|
Consolidated Net Income | $ | 2,589 |
| $ | 1,818 |
| | $ | 6,920 |
| $ | 5,549 |
|
Other Comprehensive Income: | | | | | |
Net foreign currency translation adjustments | (960 | ) | (210 | ) | | (679 | ) | (1,635 | ) |
Net gains (losses) on derivatives | 46 |
| (30 | ) | | 30 |
| 22 |
|
Net change in unrealized gains (losses) on available-for-sale debt securities | 16 |
| 10 |
| | 46 |
| (91 | ) |
Net change in pension and other benefit liabilities | 32 |
| 56 |
| | 100 |
| 372 |
|
Total Comprehensive Income | 1,723 |
| 1,644 |
| | 6,417 |
| 4,217 |
|
Less: Comprehensive income (loss) attributable to noncontrolling interests | (145 | ) | 60 |
| | (88 | ) | 9 |
|
Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company | $ | 1,868 |
| $ | 1,584 |
| | $ | 6,505 |
| $ | 4,208 |
|
Refer to Notes to Condensed Consolidated Financial Statements.
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In millions except par value)
|
| | | | | | |
| September 27, 2019 |
| December 31, 2018 |
|
ASSETS | | |
Current Assets | | |
Cash and cash equivalents | $ | 7,531 |
| $ | 9,077 |
|
Short-term investments | 2,001 |
| 2,025 |
|
Total Cash, Cash Equivalents and Short-Term Investments | 9,532 |
| 11,102 |
|
Marketable securities | 3,456 |
| 5,013 |
|
Trade accounts receivable, less allowances of $525 and $501, respectively | 4,353 |
| 3,685 |
|
Inventories | 3,266 |
| 3,071 |
|
Prepaid expenses and other assets | 2,510 |
| 2,059 |
|
Total Current Assets | 23,117 |
| 24,930 |
|
Equity method investments | 18,689 |
| 19,412 |
|
Other investments | 878 |
| 867 |
|
Other assets | 5,750 |
| 4,148 |
|
Deferred income tax assets | 2,452 |
| 2,674 |
|
Property, plant and equipment, less accumulated depreciation of $8,267 and $8,013, respectively | 10,217 |
| 9,598 |
|
Trademarks with indefinite lives | 9,167 |
| 6,682 |
|
Bottlers' franchise rights with indefinite lives | 109 |
| 51 |
|
Goodwill | 16,465 |
| 14,109 |
|
Other intangible assets | 589 |
| 745 |
|
Total Assets | $ | 87,433 |
| $ | 83,216 |
|
LIABILITIES AND EQUITY | | |
Current Liabilities | | |
Accounts payable and accrued expenses | $ | 12,727 |
| $ | 9,533 |
|
Loans and notes payable | 10,972 |
| 13,835 |
|
Current maturities of long-term debt | 492 |
| 5,003 |
|
Accrued income taxes | 909 |
| 411 |
|
Total Current Liabilities | 25,100 |
| 28,782 |
|
Long-term debt | 31,012 |
| 25,376 |
|
Other liabilities | 8,057 |
| 7,646 |
|
Deferred income tax liabilities | 2,581 |
| 2,354 |
|
The Coca-Cola Company Shareowners' Equity | | |
Common stock, $0.25 par value; authorized — 11,200 shares; issued — 7,040 and 7,040 shares, respectively | 1,760 |
| 1,760 |
|
Capital surplus | 17,039 |
| 16,520 |
|
Reinvested earnings | 65,481 |
| 63,234 |
|
Accumulated other comprehensive income (loss) | (13,706 | ) | (12,814 | ) |
Treasury stock, at cost — 2,756 and 2,772 shares, respectively | (51,861 | ) | (51,719 | ) |
Equity Attributable to Shareowners of The Coca-Cola Company | 18,713 |
| 16,981 |
|
Equity attributable to noncontrolling interests | 1,970 |
| 2,077 |
|
Total Equity | 20,683 |
| 19,058 |
|
Total Liabilities and Equity | $ | 87,433 |
| $ | 83,216 |
|
Refer to Notes to Condensed Consolidated Financial Statements.
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In millions)
|
| | | | | | |
| Nine Months Ended |
| September 27, 2019 |
| September 28, 2018 |
|
Operating Activities | | |
Consolidated net income | $ | 6,920 |
| $ | 5,549 |
|
Depreciation and amortization | 965 |
| 807 |
|
Stock-based compensation expense | 146 |
| 167 |
|
Deferred income taxes | (326 | ) | 26 |
|
Equity (income) loss — net of dividends | (336 | ) | (385 | ) |
Foreign currency adjustments | 79 |
| (169 | ) |
Significant (gains) losses — net | (389 | ) | 541 |
|
Other operating charges | 147 |
| 662 |
|
Other items | 444 |
| 130 |
|
Net change in operating assets and liabilities | 121 |
| (1,638 | ) |
Net Cash Provided by Operating Activities | 7,771 |
| 5,690 |
|
Investing Activities | |
| |
|
Purchases of investments | (4,113 | ) | (6,809 | ) |
Proceeds from disposals of investments | 5,674 |
| 11,079 |
|
Acquisitions of businesses, equity method investments and nonmarketable securities | (5,376 | ) | (598 | ) |
Proceeds from disposals of businesses, equity method investments and nonmarketable securities | 266 |
| 1,354 |
|
Purchases of property, plant and equipment | (1,206 | ) | (1,048 | ) |
Proceeds from disposals of property, plant and equipment | 944 |
| 97 |
|
Other investing activities | (90 | ) | 33 |
|
Net Cash Provided by (Used in) Investing Activities | (3,901 | ) | 4,108 |
|
Financing Activities |
|
| |
|
Issuances of debt | 19,598 |
| 21,422 |
|
Payments of debt | (21,716 | ) | (23,595 | ) |
Issuances of stock | 923 |
| 891 |
|
Purchases of stock for treasury | (690 | ) | (1,596 | ) |
Dividends | (3,419 | ) | (3,321 | ) |
Other financing activities | (33 | ) | (184 | ) |
Net Cash Provided by (Used in) Financing Activities | (5,337 | ) | (6,383 | ) |
Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents | (75 | ) | (249 | ) |
Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents |
|
|
|
|
Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the period | (1,542 | ) | 3,166 |
|
Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of period | 9,318 |
| 6,373 |
|
Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Period | 7,776 |
| 9,539 |
|
Less: Restricted cash and restricted cash equivalents at end of period | 245 |
| 318 |
|
Cash and Cash Equivalents at End of Period | $ | 7,531 |
| $ | 9,221 |
|
Refer to Notes to Condensed Consolidated Financial Statements.
THE COCA-COLA COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and notes required by U.S. GAAP for complete financial statements. However, except as disclosed herein, there has been no material change in the information disclosed in the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K of The Coca-Cola Company for the year ended December 31, 2018.
When used in these notes, the terms "The Coca-Cola Company," "Company," "we," "us" and "our" mean The Coca-Cola Company and all entities included in our condensed consolidated financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 27, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions.
Each of our interim reporting periods, other than the fourth interim reporting period, ends on the Friday closest to the last day of the corresponding quarterly calendar period. The third quarter of 2019 and the third quarter of 2018 ended on September 27, 2019 and September 28, 2018, respectively. Our fourth interim reporting period and our fiscal year end on December 31 regardless of the day of the week on which December 31 falls.
Operating Segments
In January 2019, we established a new operating segment, Global Ventures, which includes the results of Costa Limited ("Costa"), which we acquired in January 2019, and the results of our innocent and doğadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation ("Monster"). Additionally, during the second quarter of 2019, the Company updated its plans for Coca-Cola Beverages Africa Proprietary Limited ("CCBA") and now intends to maintain its majority stake in CCBA for the foreseeable future. As a result, the Company now presents the financial results of CCBA within its results from continuing operations and includes the results of CCBA in the Bottling Investments operating segment. Accordingly, all prior period operating segment and Corporate information presented herein has been adjusted to reflect these changes. Refer to Note 2 and Note 17.
As of September 27, 2019, our organizational structure consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance, and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence.
Advertising Costs
The Company's accounting policy related to advertising costs for annual reporting purposes is to expense production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred.
For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures that benefit multiple interim periods in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy.
Leases
Effective January 1, 2019, we adopted Accounting Standards Codification 842, Leases ("ASC 842"). We determine if an arrangement contains a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances.
Lessee
We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in the line items other assets, accounts payable and accrued expenses, and other liabilities in our consolidated balance sheet. Operating lease right-of-use ("ROU") assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 8 for further discussion.
Lessor
We have various arrangements for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material.
Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents
We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheet, and amounts classified in assets held for sale. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk.
The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the condensed consolidated statements of cash flows (in millions): |
| | | | | | |
| September 27, 2019 |
| December 31, 2018 |
|
Cash and cash equivalents | $ | 7,531 |
| $ | 9,077 |
|
Cash and cash equivalents included in other assets1 | 245 |
| 241 |
|
Cash, cash equivalents, restricted cash and restricted cash equivalents | $ | 7,776 |
| $ | 9,318 |
|
| September 28, 2018 |
| December 31, 2017 |
|
Cash and cash equivalents | $ | 9,221 |
| $ | 6,102 |
|
Cash and cash equivalents included in assets held for sale | — |
| 13 |
|
Cash and cash equivalents included in other assets1 | 318 |
| 258 |
|
Cash, cash equivalents, restricted cash and restricted cash equivalents | $ | 9,539 |
| $ | 6,373 |
|
1 Amounts represent cash and cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of
our European and Canadian pension plans. Refer to Note 4.
Recently Issued Accounting Guidance
Recently Adopted Accounting Guidance
ASC 842 requires lessees to recognize operating lease ROU assets, representing their right to use the underlying asset for the lease term, and operating lease liabilities on the balance sheet for all leases with lease terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted ASC 842 using the modified retrospective method and utilized the optional transition method under which we continue to apply the legacy guidance in ASC 840, Leases, including its disclosure requirements, in the comparative period presented. In addition, we elected the package of practical expedients permitted under the transition guidance which permits us to carry forward the historical lease classification, among other things. As a result of the adoption, our operating lease ROU assets and operating lease liabilities were $1,310 million and $1,329 million, respectively, as of September 27, 2019. The adoption of this standard did not impact our consolidated statement of income or our consolidated statement of cash flows. Refer to Note 8 for further discussion.
In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-12, Targeted Improvements to Accounting for Hedging Activities, which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in
the same line item in the statement of income where the hedged item resides. The amendments in this update include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2019 by $12 million, net of tax. Refer to Note 6 for additional disclosures required by this ASU.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (the "Tax Reform Act") on items within accumulated other comprehensive income (loss) ("AOCI") to reinvested earnings. These disproportionate income tax effect items are referred to as "stranded tax effects." The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019. We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $513 million.
Accounting Guidance Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for the Company beginning January 1, 2020 and is required to be applied prospectively. For our trade receivables, certain other receivables and certain other financial instruments, we will be required to use a new forward-looking "expected" credit loss model based on historical loss rates that will replace the existing "incurred" credit loss model, which will generally result in earlier recognition of allowances for credit losses. We are currently evaluating the impact that ASU 2016-13 will have on our consolidated financial statements and do not expect it will have a material impact on our financial statements or disclosures.
NOTE 2: ACQUISITIONS AND DIVESTITURES
Acquisitions
During the nine months ended September 27, 2019, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $5,376 million, which primarily related to the acquisition of Costa and the remaining equity ownership interest in C.H.I. Limited ("CHI"), a Nigerian producer of value-added dairy and juice beverages and iced tea.
During the nine months ended September 28, 2018, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $598 million, which included the acquisition of a minority interest in BA Sports Nutrition, LLC ("BodyArmor"). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor has the option to sell their remaining interests to the Company based on the same agreed-upon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation.
Costa Limited
In January 2019, the Company acquired Costa in exchange for $4.9 billion of cash, net of cash acquired. Costa is a coffee company with retail outlets in over 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. As of September 27, 2019, $2.4 billion of the purchase price was preliminarily allocated to the Costa trademark and $2.5 billion was preliminarily allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $108 million, which was allocated to the Europe, Middle East and Africa operating segment. The preliminary allocation of the purchase price is subject to refinement when valuations are finalized. As of September 27, 2019, the valuations that have not been finalized primarily relate to operating lease ROU assets and operating lease liabilities and certain fixed assets. The final purchase price allocation will be completed as soon as possible, but no later than the first quarter of 2020.
C.H.I. Limited
In January 2019, the Company acquired the remaining 60 percent interest in CHI in exchange for $260 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net charge of $121 million, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) — net in our condensed consolidated statement of income.
Divestitures
During the nine months ended September 27, 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $266 million, which primarily related to the sale of a portion of our equity method investment in Embotelladora Andina S.A. ("Andina"). We recognized a gain of $39 million as a result of the sale, which was recorded in the line item other income (loss) — net in our condensed consolidated statement of income. We continue to account for our remaining interest in Andina as an equity method investment as a result of our representation on Andina's Board of Directors and other governance rights.
During the nine months ended September 28, 2018, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,354 million, which primarily related to the proceeds from the refranchising of our Canadian and Latin American bottling operations, as well as the sale of our equity ownership in Corporación Lindley S.A. ("Lindley").
Corporación Lindley S.A.
On September 26, 2018, we sold our equity ownership in Lindley to AC Bebidas, an equity method investee. We received net
cash proceeds of $507 million and recognized a net gain of $370 million during the three and nine months ended September 28, 2018, which was included in the line item other income (loss) — net in our condensed consolidated statements of income.
Refranchising of Latin American Bottling Operations
During the nine months ended September 28, 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, S.A.B. de C.V. ("Coca-Cola FEMSA"), an equity method investee. We received net cash proceeds of $289 million as a result of these sales and recognized net gains of $11 million and $47 million during the three and nine months ended September 28, 2018, respectively, which were included in the line item other income (loss) — net in our condensed consolidated statements of income.
North America Refranchising — United States
In conjunction with implementing a new beverage partnership model in North America, in 2018 the Company completed the refranchising of all of our bottling territories in the United States that were previously managed by Coca-Cola Refreshments
("CCR") to certain of our unconsolidated bottling partners. We recognized net gains of $19 million and $15 million during the three and nine months ended September 27, 2019, respectively, and net gains of $10 million and net charges of $94 million during the three and nine months ended September 28, 2018, respectively. These net gains and net charges were included in the line item other income (loss) — net in our condensed consolidated statements of income and were primarily related to post-closing adjustments as contemplated by the related agreements.
During the three months ended September 28, 2018, the Company recorded charges of $12 million primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of comprehensive beverage agreement ("CBA") with additional requirements. During the nine months ended September 27, 2019 and September 28, 2018, the Company recorded charges of $4 million and $33 million, respectively, related to such payments. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, as well as consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The charges related to these payments were included in the line item other income (loss) — net in our condensed consolidated statements of income.
North America Refranchising — Canada
On September 28, 2018, the Company completed its North America refranchising with the sale of its Canadian bottling
operations. We received initial net cash proceeds of $518 million and recognized a net charge of $285 million during the three and nine months ended September 28, 2018. During the three and nine months ended September 27, 2019 we recognized an additional charge of $122 million primarily related to post-closing adjustments as contemplated by the related agreements. These charges were included in the line item other income (loss) — net in our condensed consolidated statements of income.
Refer to Note 17 for the impact these items had on our operating segments and Corporate.
Coca-Cola Beverages Africa Proprietary Limited
Due to the Company's original intent to refranchise CCBA, it was accounted for as held for sale and a discontinued operation
from October 2017 through the first quarter of 2019. As CCBA met the criteria to be classified as held for sale, we were
required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As a result, during
the three and nine months ended September 28, 2018, we recorded an impairment charge of $554 million, reflecting management's view of the proceeds that were expected to be received upon the sale based on revised projections of future operating results and foreign currency exchange rate fluctuations. This charge was previously reflected in the line item income (loss) from discontinued operations in our condensed consolidated statements of income, and the corresponding reduction to assets was reflected as an allowance for reduction of assets held for sale — discontinued operations in our condensed consolidated balance sheet. Additionally, CCBA's property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized.
While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during
the second quarter of 2019 the Company updated its plans for CCBA and now intends to maintain its controlling stake in
CCBA for the foreseeable future. As a result, CCBA no longer qualifies as held for sale or as a discontinued operation, and
CCBA's financial results are now presented within the Company's continuing operations for all periods presented. As a result of
this change in presentation, the Company reflected the impairment charge in other income (loss) — net in our consolidated
statements of income and reallocated the allowance for reduction of assets held for sale — discontinued operations balance to
reduce the carrying value of CCBA's property, plant and equipment by $225 million and CCBA's definite-lived intangible
assets by $329 million based on the relative amount of depreciation and amortization that would have been recognized during
the period CCBA was held for sale. We also recorded a $160 million adjustment to reduce the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by an additional $34 million and $126 million, respectively, during the nine months ended September 27, 2019. These additional adjustments were included in the line item other income (loss) — net in our condensed consolidated statement of income.
NOTE 3: REVENUE RECOGNITION
Our Company markets, manufactures and sells:
| |
• | beverage concentrates, sometimes referred to as "beverage bases," and syrups, including fountain syrups (we refer to this part of our business as our "concentrate business" or "concentrate operations"); and |
| |
• | finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our "finished product business" or "finished product operations"). |
Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations.
In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (which we typically refer to as our "bottlers" or our "bottling partners"). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment.
Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers or Company-owned Costa retail outlets. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment.
We adopted Accounting Standards Codification 606, Revenue from Contracts with Customers ("ASC 606") effective January 1, 2018 using the modified retrospective method. We have applied this standard to all contracts at the effective date and contracts entered into thereafter. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Once control is transferred to the customer and we have completed our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less.
Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we work with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrate they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the three and nine months ended September 27, 2019 related to performance obligations satisfied in prior periods was immaterial.
The following tables present net operating revenues disaggregated between the United States and International and further by line of business (in millions): |
| | | | | | | | | |
| United States |
| International |
| Total |
|
Three Months Ended September 27, 2019 |
|
|
|
|
|
|
Concentrate operations | $ | 1,414 |
| $ | 4,026 |
| $ | 5,440 |
|
Finished product operations | 1,676 |
| 2,391 |
| 4,067 |
|
Total | $ | 3,090 |
| $ | 6,417 |
| $ | 9,507 |
|
Three Months Ended September 28, 2018 |
|
|
|
|
|
|
Concentrate operations | $ | 1,191 |
| $ | 4,039 |
| $ | 5,230 |
|
Finished product operations | 1,776 |
| 1,769 |
| 3,545 |
|
Total | $ | 2,967 |
| $ | 5,808 |
| $ | 8,775 |
|
|
| | | | | | | | | |
| United States |
| International |
| Total |
|
Nine Months Ended September 27, 2019 |
|
|
|
|
|
|
Concentrate operations | $ | 4,014 |
| $ | 11,782 |
| $ | 15,796 |
|
Finished product operations | 4,824 |
| 7,578 |
| 12,402 |
|
Total | $ | 8,838 |
| $ | 19,360 |
| $ | 28,198 |
|
Nine Months Ended September 28, 2018 |
|
|
|
|
|
|
Concentrate operations | $ | 3,563 |
| $ | 11,961 |
| $ | 15,524 |
|
Finished product operations | 5,035 |
| 5,935 |
| 10,970 |
|
Total | $ | 8,598 |
| $ | 17,896 |
| $ | 26,494 |
|
Refer to Note 17 for additional revenue disclosures by operating segment and Corporate.
NOTE 4: INVESTMENTS
We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis.
Our investments in debt securities are classified as trading, available-for-sale or held-to-maturity and carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on debt securities classified as trading securities are included in net income. For debt securities classified as available-for-sale, realized gains and losses are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Refer to Note 6 for additional information related to the Company's fair value hedges of available-for-sale debt securities.
Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value of the investment to determine whether or not an impairment exists. We also perform this evaluation every reporting period for each investment for which an impairment indicator exists. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe a hypothetical marketplace participant would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value.
Equity Securities
The carrying values of our equity securities were included in the following line items in our condensed consolidated balance sheets (in millions): |
| | | | | | |
| Fair Value with Changes Recognized in Income |
| Measurement Alternative — No Readily Determinable Fair Value |
|
September 27, 2019 | | |
Marketable securities | $ | 310 |
| $ | — |
|
Other investments | 796 |
| 82 |
|
Other assets | 989 |
| — |
|
Total equity securities | $ | 2,095 |
| $ | 82 |
|
December 31, 2018 |
|
|
Marketable securities | $ | 278 |
| $ | — |
|
Other investments | 787 |
| 80 |
|
Other assets | 869 |
| — |
|
Total equity securities | $ | 1,934 |
| $ | 80 |
|
The calculation of net unrealized gains and losses recognized during the period related to equity securities still held at the end of the period is as follows (in millions): |
| | | | | | |
| Three Months Ended |
| September 27, 2019 |
| September 28, 2018 |
|
Net gains (losses) recognized during the period related to equity securities | $ | 29 |
| $ | 62 |
|
Less: Net gains (losses) recognized during the period related to equity securities sold during the period | — |
| 5 |
|
Net unrealized gains (losses) recognized during the period related to equity securities still held at the end of the period | $ | 29 |
| $ | 57 |
|
|
| | | | | | |
| Nine Months Ended |
| September 27, 2019 |
| September 28, 2018 |
|
Net gains (losses) recognized during the period related to equity securities | $ | 163 |
| $ | 21 |
|
Less: Net gains (losses) recognized during the period related to equity securities sold during the period | 16 |
| 13 |
|
Net unrealized gains (losses) recognized during the period related to equity securities still held at the end of the period | $ | 147 |
| $ | 8 |
|
Debt Securities
Our debt securities consisted of the following (in millions): |
| | | | | | | | | | | | |
| | Gross Unrealized | Estimated Fair Value |
|
| Cost |
| Gains |
| Losses |
|
September 27, 2019 | | | | |
Trading securities | $ | 45 |
| $ | 1 |
| $ | — |
| $ | 46 |
|
Available-for-sale securities | 3,445 |
| 150 |
| (2 | ) | 3,593 |
|
Total debt securities | $ | 3,490 |
| $ | 151 |
| $ | (2 | ) | $ | 3,639 |
|
December 31, 2018 | | | | |
Trading securities | $ | 45 |
| $ | — |
| $ | (1 | ) | $ | 44 |
|
Available-for-sale securities | 4,901 |
| 119 |
| (27 | ) | 4,993 |
|
Total debt securities | $ | 4,946 |
| $ | 119 |
| $ | (28 | ) | $ | 5,037 |
|
The fair values of our debt securities were included in the following line items in our condensed consolidated balance sheets (in millions): |
| | | | | | | | | | | | | |
| September 27, 2019 | | December 31, 2018 |
| Trading Securities |
| Available-for-Sale Securities |
| | Trading Securities |
| Available-for-Sale Securities |
|
Cash and cash equivalents | $ | — |
| $ | 155 |
| | $ | — |
| $ | — |
|
Marketable securities | 46 |
| 3,100 |
| | 44 |
| 4,691 |
|
Other assets | — |
| 338 |
| | — |
| 302 |
|
Total debt securities | $ | 46 |
| $ | 3,593 |
| | $ | 44 |
| $ | 4,993 |
|
The contractual maturities of these available-for-sale debt securities as of September 27, 2019 were as follows (in millions): |
| | | | | | |
| Cost |
| Estimated Fair Value |
|
Within 1 year | $ | 2,145 |
| $ | 2,200 |
|
After 1 year through 5 years | 1,038 |
| 1,102 |
|
After 5 years through 10 years | 72 |
| 85 |
|
After 10 years | 190 |
| 206 |
|
Total | $ | 3,445 |
| $ | 3,593 |
|
The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations.
The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): |
| | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 27, 2019 |
| September 28, 2018 |
| | September 27, 2019 |
| September 28, 2018 |
|
Gross gains | $ | 9 |
| $ | 11 |
| | $ | 37 |
| $ | 19 |
|
Gross losses | (1 | ) | (8 | ) | | (5 | ) | (21 | ) |
Proceeds | 1,284 |
| 3,421 |
| | 3,074 |
| 9,744 |
|
Captive Insurance Companies
In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $1,197 million as of September 27, 2019 and $1,056 million as of December 31, 2018, which are classified in the line item other assets in our condensed consolidated balance sheets because the assets are not available to satisfy our current obligations.
NOTE 5: INVENTORIES
Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions):
|
| | | | | | |
| September 27, 2019 |
| December 31, 2018 |
|
Raw materials and packaging | $ | 2,044 |
| $ | 2,025 |
|
Finished goods | 881 |
| 773 |
|
Other | 341 |
| 273 |
|
Total inventories | $ | 3,266 |
| $ | 3,071 |
|
NOTE 6: HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS
The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as "market risks." When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk.
The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated debt, in hedging relationships.
All derivative instruments are carried at fair value in our condensed consolidated balance sheet, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty.
The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair
values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our condensed consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our condensed consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings.
For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures.
The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets.
On January 1, 2019, we adopted ASU 2017-12. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in other comprehensive income. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019, we recorded a $6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019, we recorded a $24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $18 million, net of taxes.
The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions):
|
| | | | | | | |
| | Fair Value1,2 |
Derivatives Designated as Hedging Instruments | Balance Sheet Location1 | September 27, 2019 |
| December 31, 2018 |
|
Assets: | | | |
Foreign currency contracts | Prepaid expenses and other assets | $ | 80 |
| $ | 43 |
|
Foreign currency contracts | Other assets | 103 |
| 114 |
|
Interest rate contracts | Other assets | 695 |
| 88 |
|
Total assets | | $ | 878 |
| $ | 245 |
|
Liabilities: | | | |
Foreign currency contracts | Accounts payable and accrued expenses | $ | 38 |
| $ | 19 |
|
Foreign currency contracts | Other liabilities | 36 |
| 15 |
|
Commodity contracts | Accounts payable and accrued expenses | — |
| 1 |
|
Interest rate contracts | Other liabilities | — |
| 40 |
|
Total liabilities | | $ | 74 |
| $ | 75 |
|
1 All of the Company's derivative instruments are carried at fair value in our condensed consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments.
2 Refer to Note 16 for additional information related to the estimated fair value.
The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions):
|
| | | | | | | |
| | Fair Value1,2 |
Derivatives Not Designated as Hedging Instruments | Balance Sheet Location1 | September 27, 2019 |
| December 31, 2018 |
|
Assets: | | | |
Foreign currency contracts | Prepaid expenses and other assets | $ | 52 |
| $ | 61 |
|
Commodity contracts | Prepaid expenses and other assets | 1 |
| 2 |
|
Other derivative instruments | Prepaid expenses and other assets | 10 |
| 7 |
|
Other derivative instruments | Other assets | 2 |
| — |
|
Total assets | | $ | 65 |
| $ | 70 |
|
Liabilities: | | | |
Foreign currency contracts | Accounts payable and accrued expenses | $ | 33 |
| $ | 101 |
|
Foreign currency contracts | Other liabilities | 4 |
| — |
|
Commodity contracts | Accounts payable and accrued expenses | 60 |
| 38 |
|
Commodity contracts | Other liabilities | 4 |
| 8 |
|
Other derivative instruments | Accounts payable and accrued expenses | — |
| 13 |
|
Total liabilities | | $ | 101 |
| $ | 160 |
|
1 All of the Company's derivative instruments are carried at fair value in our condensed consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments.
2 Refer to Note 16 for additional information related to the estimated fair value.
Credit Risk Associated with Derivatives
We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal.
Cash Flow Hedging Strategy
The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our condensed consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years.
The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by fluctuations in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that were designated and qualify for the Company's foreign currency cash flow hedging program were $7,833 million and $3,175 million as of September 27, 2019 and December 31, 2018, respectively.
The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign
currency exchange rates. The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $3,028 million as of September 27, 2019 and December 31, 2018.
The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that have been designated and qualify for this program were $2 million and $9 million as of September 27, 2019 and December 31, 2018, respectively.
Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. As of September 27, 2019 and December 31, 2018, we did not have any interest rate swaps designated as a cash flow hedge. During the nine months ended September 28, 2018, we discontinued a cash flow hedge relationship related to these swaps. We reclassified a loss of $8 million into earnings as a result of the discontinuance.
The following tables present the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on other comprehensive income ("OCI"), AOCI and earnings (in millions):
|
| | | | | | | | | | | |
| Gain (Loss) Recognized in OCI |
| Location of Gain (Loss) Recognized in Income1 | Gain (Loss) Reclassified from AOCI into Income (Effective Portion)2 |
| Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
| 2 |
Three Months Ended September 27, 2019 | | | | | |
Foreign currency contracts | $ | 71 |
| Net operating revenues | $ | (5 | ) | $ | — |
| |
Foreign currency contracts | 3 |
| Cost of goods sold | 2 |
| — |
| |
Foreign currency contracts | — |
| Interest expense | (3 | ) | — |
| |
Foreign currency contracts | (46 | ) | Other income (loss) — net | (46 | ) | — |
| |
Interest rate contracts | (30 | ) | Interest expense | (10 | ) | — |
| |
Commodity contracts | 1 |
| Cost of goods sold | — |
| — |
| |
Total | $ | (1 | ) |
| $ | (62 | ) | $ | — |
| |
Three Months Ended September 28, 2018 | | | | | |
Foreign currency contracts | $ | 2 |
| Net operating revenues | $ | 43 |
| $ | — |
| 3 |
Foreign currency contracts | 3 |
| Cost of goods sold | 4 |
| — |
| 3 |
Foreign currency contracts | — |
| Interest expense | (2 | ) | — |
| |
Foreign currency contracts | 20 |
| Other income (loss) — net | 23 |
| 2 |
| |
Interest rate contracts | — |
| Interest expense | (9 | ) |
|