Financial Instruments
We are exposed to market risks arising from adverse changes in:
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• | commodity prices, affecting the cost of our raw materials and energy; |
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• | foreign exchange risks and currency restrictions; and |
In the normal course of business, we manage these risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging strategies. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price purchase orders and pricing agreements. Our hedging strategies include the use of derivatives. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the Consolidated Statement of Cash Flows. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See “Our Business Risks” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks.
For cash flow hedges, changes in fair value are deferred in accumulated other comprehensive loss within common shareholders’ equity until the underlying hedged item is recognized in net income. For fair value hedges, changes in fair value are recognized immediately in earnings, consistent with the underlying hedged item. Hedging transactions are limited to an underlying exposure. As a result, any change in the value of our derivative instruments would be substantially offset by an opposite change in the value of the underlying hedged items. Hedging ineffectiveness and a net earnings impact occur when the change in the value of the hedge does not fully offset the change in the value of the underlying hedged item. If the derivative instrument related to a cash flow hedge is terminated, we continue to defer the related gain or loss as part of accumulated other comprehensive loss and then include it as a component of the cost of the underlying hedged item. Upon determination that the underlying hedged item will not be part of an actual transaction, we recognize the related gain or loss on the hedge in net income immediately.
We also use derivatives that do not qualify for hedge accounting treatment. We account for such derivatives at market value with the resulting gains and losses reflected in our income statement. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk.
Commodity Prices
We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivatives. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals. For those derivatives that qualify for hedge accounting, any ineffectiveness is recorded immediately in corporate unallocated expenses. Ineffectiveness was not material for all periods presented. During the next 12 months, we expect to reclassify net losses of $26 million related to these hedges from accumulated other comprehensive loss into net income. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in net income.
Our open commodity derivative contracts that qualify for hedge accounting had a face value of $494 million as of December 28, 2013 and $507 million as of December 29, 2012.
Our open commodity derivative contracts that do not qualify for hedge accounting had a face value of $881 million as of December 28, 2013 and $853 million as of December 29, 2012.
Foreign Exchange
Our operations outside of the U.S. generate 49% of our net revenue, with Russia, Mexico, Canada, the United Kingdom and Brazil comprising approximately 25% of our net revenue in 2013. As a result, we are exposed to foreign exchange risks.
Additionally, we are also exposed to foreign exchange risk from foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in our income statement as incurred.
Our foreign currency derivatives had a total face value of $2.5 billion as of December 28, 2013 and $2.8 billion as of December 29, 2012. During the next 12 months, we expect to reclassify net gains of $11 million related to foreign currency derivative contracts that qualify for hedge accounting from accumulated other comprehensive loss into net income. Ineffectiveness was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all losses and gains were offset by changes in the underlying hedged items, resulting in no net material impact on earnings.
Interest Rates
We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness has been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions.
The notional amounts of the interest rate derivative instruments outstanding as of December 28, 2013 and December 29, 2012 were $7.9 billion and $8.1 billion, respectively. For those interest rate derivative instruments that qualify for cash flow hedge accounting, any ineffectiveness is recorded immediately. Ineffectiveness was not material for all periods presented. During the next 12 months, we expect to reclassify net losses of $23 million related to these hedges from accumulated other comprehensive loss into net income.
As of December 28, 2013, approximately 31% of total debt, after the impact of the related interest rate derivative instruments, was exposed to variable rates, compared to 27% as of December 29, 2012.
Fair Value Measurements
The fair values of our financial assets and liabilities as of December 28, 2013 and December 29, 2012 are categorized as follows:
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| | | | | | | | | | | | | | | |
| 2013 | | 2012 |
| Assets(a) | | Liabilities(a) | | Assets(a) | | Liabilities(a) |
Available-for-sale securities(b) | $ | 135 |
| | $ | — |
| | $ | 79 |
| | $ | — |
|
Short-term investments – index funds(c) | $ | 184 |
| | $ | — |
| | $ | 161 |
| | $ | — |
|
Prepaid forward contracts(d) | $ | 24 |
| | $ | — |
| | $ | 33 |
| | $ | — |
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Deferred compensation(e) | $ | — |
| | $ | 504 |
| | $ | — |
| | $ | 492 |
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Derivatives designated as fair value hedging instruments: | | | | | | | |
Interest rate(f) | $ | 176 |
| | $ | 10 |
| | $ | 276 |
| | $ | — |
|
Derivatives designated as cash flow hedging instruments: | | | | | | | |
Foreign exchange(g) | $ | 22 |
| | $ | 13 |
| | $ | 5 |
| | $ | 19 |
|
Interest rate(f) | 19 |
| | — |
| | 6 |
| | — |
|
Commodity(h) | 6 |
| | 29 |
| | 8 |
| | 24 |
|
| $ | 47 |
| | $ | 42 |
| | $ | 19 |
| | $ | 43 |
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Derivatives not designated as hedging instruments: | | | | | | | |
Foreign exchange(g) | $ | 12 |
| | $ | 8 |
| | $ | 8 |
| | $ | 6 |
|
Interest rate(f) | 71 |
| | 94 |
| | 123 |
| | 153 |
|
Commodity(h) | 20 |
| | 89 |
| | 40 |
| | 45 |
|
| $ | 103 |
| | $ | 191 |
| | $ | 171 |
| | $ | 204 |
|
Total derivatives at fair value | $ | 326 |
| | $ | 243 |
| | $ | 466 |
| | $ | 247 |
|
Total | $ | 669 |
| | $ | 747 |
| | $ | 739 |
| | $ | 739 |
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(a) | Financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets, with the exception of available-for-sale securities and short-term investments, which are classified as short-term investments. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. Unless specifically indicated, all financial assets and liabilities are categorized as Level 2 assets or liabilities. |
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(b) | Based on the price of common stock. Categorized as a Level 1 asset. |
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(c) | Based on the price of index funds. Categorized as a Level 1 asset. |
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(d) | Based primarily on the price of our common stock. |
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(e) | Based on the fair value of investments corresponding to employees’ investment elections. As of December 28, 2013, all balances are categorized as Level 2 liabilities. As of December 29, 2012, $10 million are categorized as Level 1 liabilities and the remaining balances are categorized as Level 2 liabilities. |
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(f) | Based on LIBOR forward rates and recently reported market transactions of spot and forward rates. |
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(g) | Based on recently reported market transactions of spot and forward rates. |
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(h) | Based on recently reported market transactions, primarily swap arrangements. |
The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to the short-term maturity. Short-term investments consist principally of short-term time deposits and index funds used to manage a portion of market risk arising from our deferred compensation liability. The fair value of our debt obligations as of December 28, 2013 and December 29, 2012 was $29.7 billion and $30.5 billion, respectively, based upon prices of similar instruments in the marketplace.
The effective portion of the pre-tax losses/(gains) on our derivative instruments is categorized in the table below.
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| | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value/Non- designated Hedges | | Cash Flow Hedges |
| Losses/(Gains) Recognized in Income Statement(a) | | Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss | | Losses Reclassified from Accumulated Other Comprehensive Loss into Income Statement(b) |
2013 |
| | 2012 |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
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Foreign exchange | $ | (9 | ) | | $ | (23 | ) | | $ | (24 | ) | | $ | 41 |
| | $ | — |
| | $ | 8 |
|
Interest rate | 99 |
| | 17 |
| | (13 | ) | | (2 | ) | | 3 |
| | 19 |
|
Commodity | 126 |
| | (23 | ) | | 57 |
| | 11 |
| | 42 |
| | 63 |
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Total | $ | 216 |
| | $ | (29 | ) | | $ | 20 |
| | $ | 50 |
| | $ | 45 |
| | $ | 90 |
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(a) | Foreign exchange derivative gains/losses are primarily included in selling, general and administrative expenses. Interest rate derivative losses are primarily from fair value hedges and are included in interest expense. These losses are substantially offset by decreases in the value of the underlying debt, which are also included in interest expense. Commodity derivative gains/losses are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. |
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(b) | Foreign exchange derivative gains/losses are primarily included in cost of sales. Interest rate derivative losses are included in interest expense. Commodity derivative gains/losses are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. |
