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Dynamic quotes 
OFFON

THE COCA-COLA COMPANY

(KO)
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COCA COLA : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

07/26/2021 | 04:40pm EDT
When used in this report, 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.
During the six months ended July 2, 2021, the effects of the COVID-19 pandemic
and the related actions by governments around the world to attempt to contain
the spread of the virus continued to impact our business globally. In
particular, the outbreak and preventive measures taken to contain COVID-19,
including the spread of new variants, negatively impacted our unit case volume
and our price, product and geographic mix, primarily due to unfavorable channel
and product mix as consumer demand has shifted to more at-home consumption
versus away-from-home consumption. However, the timing and number of people
receiving vaccinations, the governmental actions to reopen certain economies
around the world, and the substance and pace of the post-pandemic economic
recovery are favorably impacting our business when compared to the prior year
results. While uncertainty caused by the COVID-19 pandemic remains, including
the spread of new variants of the virus, we expect to continue to see
improvements in our business as vaccines become more widely available around the
world and global vaccination rates increase.
During the COVID-19 pandemic and related business disruption, the Company's
priorities are ensuring the health and safety of our employees; supporting and
making a difference in the communities we serve; keeping our brands in supply
and maintaining the quality and safety of our products; serving our customers
across all channels as they adapt to the shifting demands of consumers during
the pandemic; and positioning ourselves to emerge stronger from the pandemic.
Throughout the COVID-19 pandemic, business continuity and adapting to the needs
of our customers have been critical. We have developed systemwide
knowledge-sharing routines and processes, which include the management of any
supply chain challenges. There is a high degree of variation in COVID-19
vaccination rates and government-imposed mobility restrictions in the countries
and territories where our products are sold. However, as of the date of this
filing, there has been no material impact, and we do not foresee a material
impact, on our and our bottling partners' ability to manufacture or distribute
our products. Together with our bottlers and customers, we are working to ensure
adequate inventory levels and partnering to forecast demand given changing
conditions related to vaccination rates, infection levels and any
government-imposed mobility restrictions. In addition, we continue to increase
investments in e-commerce to support retailer and meal delivery services.
Although we have been experiencing significant challenges as a result of the
COVID-19 pandemic, we are not losing sight of long-term opportunities for our
business. We believe that we will emerge from this situation as a better and
stronger company. We are leveraging the pandemic as a catalyst to accelerate our
strategy by focusing on the following: prioritizing stronger global brands
across various consumer needs while, at the same time, doing a better job of
nurturing and growing regional and scaled local brands; establishing a more
disciplined innovation framework and increasing marketing effectiveness and
efficiency; strengthening our revenue growth management capabilities; enhancing
our system collaboration and capturing supply chain efficiencies; and investing
in new capabilities and evolving our organization to support the accelerated
strategy. In August 2020, the Company announced strategic steps to transform our
organizational structure in an effort to better enable us to capture growth in
the fast-changing marketplace. The Company is building a networked global
organization designed to combine the power of scale with the deep knowledge
required to win locally. These organizational changes required a reallocation of
resources, along with both voluntary and involuntary reductions of associates.
Refer to Note 12 of Notes to Condensed Consolidated Financial Statements for
additional information about our strategic realignment initiatives.
                   CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Recoverability of Current and Noncurrent Assets
Our Company faces many uncertainties and risks related to various economic,
political and regulatory environments in the countries in which we operate,
particularly in developing and emerging markets. Refer to the heading "Item 1A.
Risk Factors" in Part I and "Our Business - Challenges and Risks" in Part II of
our Annual Report on Form 10-K for the year ended December 31, 2020, as well as
"Item 1A. Risk Factors" in Part II of our Quarterly Report on Form 10-Q for the
quarter ended April 2, 2021. As a result, management must make numerous
assumptions, which involve a significant amount of judgment, when completing
recoverability and impairment tests of current and noncurrent assets in various
regions around the world.
We perform recoverability and impairment tests of current and noncurrent assets
in accordance with accounting principles generally accepted in the United States
("U.S. GAAP"). For certain assets, recoverability and/or impairment tests are
required only when conditions exist that indicate the carrying value may not be
recoverable. For other assets, impairment tests are required at least annually,
or more frequently if events or circumstances indicate that an asset may be
impaired.
The assessment of recoverability and the performance of impairment tests of
current and noncurrent assets involve critical accounting estimates. These
estimates require significant management judgment, include inherent
uncertainties and are often interdependent; therefore, they do not change in
isolation. Factors that management must estimate include, among others, the
economic lives of the assets, sales volume, pricing, royalty rates, costs of raw
materials, delivery costs, inflation, cost of capital,
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marketing spending, foreign currency exchange rates, tax rates, capital
spending, proceeds from the sale of assets and customers' financial condition.
These factors are even more difficult to estimate as a result of uncertainties
associated with the scope, severity and duration of the global COVID-19 pandemic
and any resurgences of the pandemic including, but not limited to, the number of
people contracting the virus; the impact of shelter-in-place and social
distancing requirements; the impact of governmental actions across the globe to
contain the virus; vaccine availability, rates of vaccination, and effectiveness
of vaccines against existing and new variants of the virus; and the substance
and pace of the post-pandemic economic recovery. The estimates we use when
assessing the recoverability of assets are consistent with those we use in our
internal planning. When performing impairment tests, we estimate the fair values
of the assets using management's best assumptions, which we believe are
consistent with those a market participant would use. The variability of these
factors depends on a number of conditions, including uncertainties associated
with the COVID-19 pandemic, and thus our accounting estimates may change from
period to period. Our current estimates reflect our belief that COVID-19 will
impact our business for the remainder of 2021, with the first half of the year
likely to be more challenging than the second half. While uncertainty still
exists, we expect to see continued improvements in our business as vaccines
become more widely available, as global vaccination rates increase, and as
consumers return to many of their previous work routines as well as socializing
and traveling. The Company has certain intangible and other long-lived assets
that are more dependent on cash flows generated in away-from-home channels
and/or that generate cash flows in geographic areas that are more heavily
impacted by the COVID-19 pandemic and are therefore more susceptible to
impairment. In addition, intangible and other long-lived assets we acquired in
recent transactions are naturally more susceptible to impairment, because they
are recorded at fair value based on recent operating plans and macroeconomic
conditions at the time of acquisition. If we had used other assumptions and
estimates when tests of these assets were performed, impairment charges could
have resulted. Furthermore, if management uses different assumptions or if
different conditions exist in future periods, future impairment charges could
result. The total future impairment charges we may be required to record could
be material.
Our equity method investees also perform such recoverability and/or impairment
tests. If an impairment charge is recorded by one of our equity method
investees, the Company records its proportionate share of such charge as a
reduction of equity income (loss) - net in our consolidated statement of income.
However, the actual amount we record with respect to our proportionate share of
such charge may be impacted by items such as basis differences, deferred taxes
and deferred gains.
                               OPERATIONS REVIEW
Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with
the second and third calendar quarters typically accounting for the highest
sales volumes. The volume of sales in the beverage business may be affected by
weather conditions.
Structural Changes, Acquired Brands and Newly Licensed Brands
In order to continually improve upon the Company's operating performance, from
time to time, we engage in buying and selling ownership interests in bottling
partners and other manufacturing operations. In addition, we also acquire brands
and their related operations or enter into license agreements for certain brands
to supplement our beverage offerings. These items impact our operating results
and certain key metrics used by management in assessing the Company's
performance.
Unit case volume growth is a metric used by management to evaluate the Company's
performance because it measures demand for our products at the consumer level.
The Company's unit case volume represents the number of unit cases (or unit case
equivalents) of Company beverage products directly or indirectly sold by the
Company and its bottling partners to customers or consumers and, therefore,
reflects unit case volume for both consolidated and unconsolidated bottlers.
Refer to the heading "Beverage Volume" below.
Concentrate sales volume represents the amount of concentrates, syrups, source
waters and powders/minerals (in all instances expressed in unit case
equivalents) sold by, or used in finished products sold by, the Company to its
bottling partners or other customers. For Costa Limited ("Costa")
non-ready-to-drink beverage products, concentrate sales volume represents the
amount of coffee (in all instances expressed in unit case equivalents) sold by
the Company to customers or consumers. Refer to the heading "Beverage Volume"
below.
When we analyze our net operating revenues we generally consider the following
factors: (1) volume growth (concentrate sales volume or unit case volume, as
applicable); (2) changes in price, product and geographic mix; (3) foreign
currency fluctuations; and (4) acquisitions and divestitures (including
structural changes defined below), as applicable. Refer to the heading "Net
Operating Revenues" below. The Company sells concentrates and syrups to both
consolidated and unconsolidated bottling partners. The ownership structure of
our bottling partners impacts the timing of recognizing concentrate revenue and
concentrate sales volume. When we sell concentrates or syrups to our
consolidated bottling partners, we do not recognize the concentrate revenue or
concentrate sales volume until the bottling partner has sold finished products
manufactured from the concentrates or syrups to a third party. When we sell
concentrates or syrups to our unconsolidated bottling partners, we recognize the
concentrate revenue and concentrate sales volume when the concentrates or syrups
are sold to the bottling partner. The subsequent sale of the finished products
manufactured from the concentrates or syrups to a third party does not impact
the
                                       37
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timing of recognizing the concentrate revenue or concentrate sales volume. When
we account for an unconsolidated bottling partner as an equity method
investment, we eliminate the intercompany profit related to these transactions
to the extent of our ownership interest until the equity method investee has
sold finished products manufactured from the concentrates or syrups to a third
party. We typically report unit case volume when finished products manufactured
from the concentrates or syrups are sold to a third party, regardless of our
ownership interest in the bottling partner, if any.
We generally refer to acquisitions and divestitures of bottling operations as
"structural changes," which are a component of acquisitions and divestitures.
Typically, structural changes do not impact the Company's unit case volume or
concentrate sales volume on a consolidated basis or at the geographic operating
segment level. We recognize unit case volume for all sales of Company beverage
products, regardless of our ownership interest in the bottling partner, if any.
However, the unit case volume reported by our Bottling Investments operating
segment is generally impacted by structural changes because it only includes the
unit case volume of our consolidated bottling operations.
"Acquired brands" refers to brands acquired during the past 12 months.
Typically, the Company has not reported unit case volume or recognized
concentrate sales volume related to an acquired brand in periods prior to the
closing of a transaction. Therefore, the unit case volume and concentrate sales
volume related to an acquired brand are incremental to prior year volume. We
generally do not consider the acquisition of a brand to be a structural change.
"Licensed brands" refers to brands not owned by the Company but for which we
hold certain rights, generally including, but not limited to, distribution
rights, and from which we derive an economic benefit when the products are sold.
Typically, the Company has not reported unit case volume or recognized
concentrate sales volume related to a licensed brand in periods prior to the
beginning of the term of a license agreement. Therefore, in the year a license
agreement is entered into, the unit case volume and concentrate sales volume
related to a licensed brand are incremental to prior year volume. We generally
do not consider the licensing of a brand to be a structural change.
In 2020, the Company discontinued our Odwalla juice business. The impact of
discontinuing our Odwalla juice business has been included in acquisitions and
divestitures in our analysis of net operating revenues on a consolidated basis
as well as for the North America operating segment.
Beverage Volume
We measure the volume of Company beverage products sold in two ways: (1) unit
cases of finished products and (2) concentrate sales. As used in this report,
"unit case" means a unit of measurement equal to 192 U.S. fluid ounces of
finished beverage (24 eight-ounce servings), with the exception of unit case
equivalents for Costa non-ready-to-drink beverage products, which are primarily
measured in number of transactions; and "unit case volume" means the number of
unit cases (or unit case equivalents) of Company beverage products directly or
indirectly sold by the Company and its bottling partners to customers or
consumers. Unit case volume primarily consists of beverage products bearing
Company trademarks. Also included in unit case volume are certain brands
licensed to, or distributed by, our Company, and brands owned by Coca-Cola
system bottlers for which our Company provides marketing support and from the
sale of which we derive economic benefit. In addition, unit case volume includes
sales by certain joint ventures in which the Company has an ownership interest.
We believe unit case volume is one of the measures of the underlying strength of
the Coca-Cola system because it measures trends at the consumer level. The unit
case volume numbers used in this report are derived based on estimates received
by the Company from its bottling partners and distributors. Concentrate sales
volume represents the amount of concentrates, syrups, source waters and
powders/minerals (in all instances expressed in unit case equivalents) sold by,
or used in finished beverages sold by, the Company to its bottling partners or
other customers. For Costa non-ready-to-drink beverage products, concentrate
sales volume represents the amount of coffee (in all instances expressed in unit
case equivalents) sold by the Company to customers or consumers. Unit case
volume and concentrate sales volume growth rates are not necessarily equal
during any given period. Factors such as seasonality, bottlers' inventory
practices, supply point changes, timing of price increases, new product
introductions and changes in product mix can create differences between unit
case volume and concentrate sales volume growth rates. In addition to these
items, the impact of unit case volume from certain joint ventures in which the
Company has an ownership interest, but to which the Company does not sell
concentrates, syrups, source waters or powders/minerals, may give rise to
differences between unit case volume and concentrate sales volume growth rates.
                                       38
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Information about our volume growth worldwide and by operating segment is as follows:

Percent Change 2021 versus 2020

                                                         Three Months Ended                                   Six Months Ended
                                                            July 2, 2021                                        July 2, 2021
                                               Unit Cases1,2,3         Concentrate Sales4          Unit Cases1,2,3         Concentrate Sales4
Worldwide                                                18  %                      26  %                     9  %                      15  %
Europe, Middle East & Africa                             21  %                      41  %                     9  %                      18  %
Latin America                                            12                         29                        6                         14
North America                                            17                         16                        5                          8
Asia Pacific                                             16                         15                       13                         17
Global Ventures                                          48                         60                       19                         27
Bottling Investments                                     25                           N/A                    14                           N/A


1 Bottling Investments operating segment data reflects unit case volume growth
for consolidated bottlers only.
2 Geographic and Global Ventures operating segment data reflects unit case
volume growth for all bottlers, both consolidated and unconsolidated, and
distributors in the applicable geographic areas. Global Ventures operating
segment data also reflects unit case volume growth for Costa retail stores.
3 Unit case volume percent change is based on average daily sales. Unit case
volume growth based on average daily sales is computed by comparing the average
daily sales in each of the corresponding periods. Average daily sales are the
unit cases sold during the period divided by the number of days in the period.
4 Concentrate sales volume represents the amount of concentrates, syrups, source
waters and powders/minerals (in all instances expressed in unit case
equivalents) sold by, or used in finished beverages sold by, the Company to its
bottling partners or other customers and is not based on average daily sales.
For Costa non-ready-to-drink products, concentrate sales volume represents the
amount of coffee (in all instances expressed in unit case equivalents) sold by
the Company to customers or consumers and is not based on average daily sales.
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. As a result, the first quarter of 2021 had five
additional days when compared to the first quarter of 2020, and the fourth
quarter of 2021 will have six fewer days when compared to the fourth quarter of
2020.
Unit Case Volume
Although a significant portion of our Company's revenues is not based directly
on unit case volume, we believe unit case
volume is one of the measures of the underlying strength of the Coca-Cola system
because it measures trends at the consumer level.
Three Months Ended July 2, 2021 versus Three Months Ended June 26, 2020
Unit case volume in Europe, Middle East and Africa increased 21 percent, which
included 19 percent growth in Trademark Coca-Cola, 20 percent growth in
sparkling flavors, 27 percent growth in hydration, sports, coffee and tea, and
32 percent growth in nutrition, juice, dairy and plant-based beverages. The
operating segment reported growth in unit case volume of 21 percent in the
Europe operating unit, 22 percent in the Africa operating unit and 20 percent in
the Eurasia and Middle East operating unit.
Unit case volume in Latin America increased 12 percent, which included 8 percent
growth in Trademark Coca-Cola, 19 percent growth in hydration, sports, coffee
and tea, 17 percent growth in sparkling flavors and 19 percent growth in
nutrition, juice, dairy and plant-based beverages. The operating segment's
volume performance included 17 percent growth in Brazil and 4 percent growth in
Mexico.
Unit case volume in North America increased 17 percent, which included 28
percent growth in hydration, sports, coffee and tea, 24 percent growth in
sparkling flavors, 8 percent growth in Trademark Coca-Cola and 17 percent growth
in nutrition, juice, dairy and plant-based beverages.
Unit case volume in Asia Pacific increased 16 percent, which included 19 percent
growth in hydration, sports, coffee and tea, 15 percent growth in sparkling
flavors, 12 percent growth in Trademark Coca-Cola and 34 percent growth in
nutrition, juice, dairy and plant-based beverages. The operating segment
reported growth in unit case volume of 61 percent in the India and Southwest
Asia operating unit, 10 percent in the Greater China and Mongolia operating
unit, 12 percent in the ASEAN and South Pacific operating unit and 9 percent in
the Japan and South Korea operating unit.
Unit case volume for Global Ventures increased 48 percent, driven by 71 percent
growth in hydration, sports, coffee and tea, 15 percent growth in nutrition,
juice, dairy and plant-based beverages, and growth in energy drinks.
Unit case volume for Bottling Investments increased 25 percent, which primarily
reflects growth in India and South Africa.
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Six Months Ended July 2, 2021 versus Six Months Ended June 26, 2020
Unit case volume in Europe, Middle East and Africa increased 9 percent, which
included 11 percent growth in Trademark Coca-Cola, 10 percent growth in
sparkling flavors, 17 percent growth in nutrition, juice, dairy and plant-based
beverages, and even performance in hydration, sports, coffee and tea. The
operating segment reported growth in unit case volume of 15 percent in the
Eurasia and Middle East operating unit, 11 percent in the Africa operating unit
and 6 percent in the Europe operating unit.
Unit case volume in Latin America increased 6 percent, which included 7 percent
growth in Trademark Coca-Cola, 7 percent growth in sparkling flavors, 4 percent
growth in hydration, sports, coffee and tea, and 8 percent growth in nutrition,
juice, dairy and plant-based beverages. The operating segment's volume
performance included 8 percent growth in Brazil and 2 percent growth in Mexico.
Unit case volume in North America increased 5 percent, which included 6 percent
growth in hydration, sports, coffee and tea, 8 percent growth in sparkling
flavors, 2 percent growth in Trademark Coca-Cola and 6 percent growth in
nutrition, juice, dairy and plant-based beverages.
Unit case volume in Asia Pacific increased 13 percent, which included 13 percent
growth in Trademark Coca-Cola, 13 percent growth in sparkling flavors, 8 percent
growth in hydration, sports, coffee and tea, and 25 percent growth in nutrition,
juice, dairy and plant-based beverages. The operating segment reported growth in
unit case volume of 14 percent in the Greater China and Mongolia operating unit,
40 percent in the India and Southwest Asia operating unit, 4 percent in the
ASEAN and South Pacific operating unit and 2 percent in the Japan and South
Korea operating unit.
Unit case volume for Global Ventures increased 19 percent, driven by 10 percent
growth in hydration, sports, coffee and tea, 2 percent growth in nutrition,
juice, dairy and plant-based beverages, and growth in energy drinks.
Unit case volume for Bottling Investments increased 14 percent, which primarily
reflects growth in India and South Africa.
Concentrate Sales Volume
During the three months ended July 2, 2021, worldwide concentrate sales volume
increased 26 percent and unit case volume increased 18 percent compared to the
three months ended June 26, 2020. During the six months ended July 2, 2021,
worldwide concentrate sales volume increased 15 percent and unit case volume
increased 9 percent compared to the six months ended June 26, 2020. Concentrate
sales volume growth is calculated based on the amount of concentrate sold during
the reporting periods, which is impacted by the number of days. Conversely, unit
case volume growth is calculated based on average daily sales, which is not
impacted by the number of days in the reporting periods. The first quarter of
2021 had five additional days when compared to the first quarter of 2020, which
contributed to the differences between concentrate sales volume and unit case
volume growth rates on a consolidated basis and for the individual operating
segments during the six months ended July 2, 2021. In addition, the differences
between concentrate sales volume and unit case volume growth rates during the
three and six months ended July 2, 2021 were also impacted by the timing of
concentrate shipments, as bottlers adjusted inventory levels in the prior year
due to COVID-19 uncertainty. We expect the differences between concentrate sales
volume and unit case sales volume growth rates to reduce over the remainder of
the year primarily as a result of the fourth quarter of 2021 having six fewer
days when compared to the fourth quarter of 2020.
                                       40
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Net Operating Revenues
Three Months Ended July 2, 2021 versus Three Months Ended June 26, 2020
During the three months ended July 2, 2021, net operating revenues were $10,129
million, compared to $7,150 million during the three months ended June 26, 2020,
an increase of $2,979 million, or 42 percent.
The following table illustrates, on a percentage basis, the estimated impact of
the factors resulting in the increase (decrease) in net operating revenues on a
consolidated basis and for each of our operating segments:
                                                                         

Percent Change 2021 versus 2020

                                                                 Price, 

Product & Foreign Currency Acquisitions &

                                                     Volume1       Geographic Mix           Fluctuations           Divestitures2           Total
Consolidated                                           26  %                11  %                   5  %                    -  %           42  %
Europe, Middle East & Africa                           41  %                20  %                   6  %                    -  %           67  %
Latin America                                          29                    9                      3                       -              41
North America                                          16                   12                      1                      (1)             28
Asia Pacific                                           15                    6                      6                       -              27
Global Ventures                                        60                   57                     23                       -             139
Bottling Investments                                   25                    3                      9                       -              38


Note: Certain rows may not add due to rounding.
1 Represents the percent change in net operating revenues attributable to the
increase (decrease) in concentrate sales volume for our geographic operating
segments and our Global Ventures operating segment (expressed in unit case
equivalents) after considering the impact of acquisitions and divestitures. For
our Bottling Investments operating segment, this represents the percent change
in net operating revenues attributable to the increase (decrease) in unit case
volume computed by comparing the total sales (rather than the average daily
sales) in each of the corresponding periods after considering the impact of
structural changes, if any. Our Bottling Investments operating segment data
reflects unit case volume growth for consolidated bottlers only after
considering the impact of structural changes, if any. Refer to the heading
"Beverage Volume" above.
2 Includes structural changes, if any. Refer to the heading "Structural Changes,
Acquired Brands and Newly Licensed Brands" above.
Refer to the heading "Beverage Volume" above for additional information related
to changes in our unit case and concentrate sales volumes.
"Price, product and geographic mix" refers to the change in net operating
revenues caused by factors such as price changes, the mix of products and
packages sold, and the mix of channels and geographic territories where the
sales occurred. The impact of price, product and geographic mix is calculated by
subtracting the change in net operating revenues resulting from volume increases
or decreases, changes in foreign currency exchange rates, and acquisitions and
divestitures from the total change in net operating revenues. Management
believes that providing investors with price, product and geographic mix
enhances their understanding about the combined impact that the following items
had on the Company's net operating revenues: (1) pricing actions taken by the
Company and, where applicable, our bottling partners; (2) changes in the mix of
products and packages sold; (3) changes in the mix of channels where products
were sold; and (4) changes in the mix of geographic territories where products
were sold. Management uses this measure in making financial, operating and
planning decisions and in evaluating the Company's performance.
Price, product and geographic mix had an 11 percent favorable impact on our
consolidated net operating revenues. Price, product and geographic mix was
impacted by a variety of factors and events including, but not limited to, the
following:
•Europe, Middle East and Africa - favorable channel and package mix, partially
offset by unfavorable geographic mix;
•Latin America - favorable pricing initiatives, including inflationary pricing
in Argentina, along with favorable channel and package mix;
•North America - favorable channel and package mix;
•Asia Pacific - favorable product, channel and package mix;
•Global Ventures - favorable product and channel mix primarily due to the
reopening of Costa retail stores; and
•Bottling Investments - favorable price, category and package mix, partially
offset by unfavorable geographic mix.
The favorable channel and package mix for the three months ended July 2, 2021 in
all applicable operating segments was primarily a result of the gradual
reopening of away-from-home channels in many markets in the current year and the
impact of shelter-in-place and social distancing requirements in the prior year.
                                       41
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Fluctuations in foreign currency exchange rates increased our consolidated net
operating revenues by 5 percent. This favorable impact was primarily due to a
weaker U.S. dollar compared to certain foreign currencies, including the South
African rand, British pound sterling, euro, Mexican peso, Chinese yuan and
Philippine peso, which had a favorable impact on our Europe, Middle East and
Africa, Latin America, Asia Pacific, Global Ventures and Bottling Investments
operating segments. The favorable impact of a weaker U.S. dollar compared to the
currencies listed above was partially offset by the impact of a stronger U.S.
dollar compared to certain other foreign currencies, including the Argentine
peso and Turkish lira, which had an unfavorable impact on our Latin America and
Europe, Middle East and Africa operating segments. Refer to the heading
"Liquidity, Capital Resources and Financial Position - Foreign Exchange"
below.
"Acquisitions and divestitures" generally refers to acquisitions and
divestitures of brands or businesses, some of which the Company considers to be
structural changes. The impact of acquisitions and divestitures is the
difference between the change in net operating revenues and the change in what
our net operating revenues would have been if we removed the net operating
revenues associated with an acquisition or divestiture from either the current
year or the prior year, as applicable. Management believes that quantifying the
impact that acquisitions and divestitures had on the Company's net operating
revenues provides investors with useful information to enhance their
understanding of the Company's net operating revenue performance by improving
their ability to compare our period-to-period results. Management considers the
impact of acquisitions and divestitures when evaluating the Company's
performance. Refer to the heading "Structural Changes, Acquired Brands and Newly
Licensed Brands" above for additional information related to acquisitions and
divestitures.
Six Months Ended July 2, 2021 versus Six Months Ended June 26, 2020
During the six months ended July 2, 2021, net operating revenues were $19,149
million, compared to $15,751 million during the six months ended June 26, 2020,
an increase of $3,398 million, or 22 percent.
The following table illustrates, on a percentage basis, the estimated impact of
the factors resulting in the increase (decrease) in net operating revenues on a
consolidated basis and for each of our operating segments:
                                                                         

Percent Change 2021 versus 2020

                                                                 Price, 

Product & Foreign Currency Acquisitions &

                                                     Volume1       Geographic Mix           Fluctuations           Divestitures2           Total
Consolidated                                           15  %                 5  %                   2  %                    -  %           22  %
Europe, Middle East & Africa                           18  %                 3  %                   3  %                    -  %           24  %
Latin America                                          14                    7                     (5)                      -              17
North America                                           8                    8                      -                      (1)             15
Asia Pacific                                           17                    2                      6                       -              26
Global Ventures                                        27                    9                     11                       -              47
Bottling Investments                                   18                    4                      3                       -              24


Note: Certain rows may not add due to rounding.
1 Represents the percent change in net operating revenues attributable to the
increase (decrease) in concentrate sales volume for our geographic operating
segments and our Global Ventures operating segment (expressed in unit case
equivalents) after considering the impact of acquisitions and divestitures. For
our Bottling Investments operating segment, this represents the percent change
in net operating revenues attributable to the increase (decrease) in unit case
volume computed by comparing the total sales (rather than the average daily
sales) in each of the corresponding periods after considering the impact of
structural changes, if any. Our Bottling Investments operating segment data
reflects unit case volume growth for consolidated bottlers only after
considering the impact of structural changes, if any. Refer to the heading
"Beverage Volume" above.
2 Includes structural changes, if any. Refer to the heading "Structural Changes,
Acquired Brands and Newly Licensed Brands" above.
Refer to the heading "Beverage Volume" above for additional information related
to changes in our unit case and concentrate sales volumes.
Price, product and geographic mix had a 5 percent favorable impact on our
consolidated net operating revenues. Price, product and geographic mix was
impacted by a variety of factors and events including, but not limited to, the
following:
•Europe, Middle East and Africa - favorable channel and package mix, partially
offset by unfavorable geographic mix;
•Latin America - favorable pricing initiatives, including inflationary pricing
in Argentina, along with favorable channel and package mix;
•North America - favorable channel and package mix;
•Asia Pacific - favorable product, channel and package mix, partially offset by
unfavorable geographic mix;
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•Global Ventures - favorable channel mix primarily due to the reopening of Costa
retail stores, partially offset by unfavorable product mix; and
•Bottling Investments - favorable price, category and package mix, partially
offset by unfavorable geographic mix.
The favorable channel and package mix for the six months ended July 2, 2021 in
all applicable operating segments was primarily a result of the gradual
reopening of away-from-home channels in many markets in the current year and the
impact of shelter-in-place and social distancing requirements in the prior year.
Fluctuations in foreign currency exchange rates increased our consolidated net
operating revenues by 2 percent. This favorable impact was primarily due to a
weaker U.S. dollar compared to certain foreign currencies, including the British
pound sterling, euro, South African rand, Mexican peso, Chinese yuan and
Philippine peso, which had a favorable impact on our Europe, Middle East and
Africa, Latin America, Asia Pacific, Global Ventures and Bottling Investments
operating segments. The favorable impact of a weaker U.S. dollar compared to the
currencies listed above was partially offset by the impact of a stronger U.S.
dollar compared to certain other foreign currencies, including the Argentine
peso, Brazilian real and Turkish lira, which had an unfavorable impact on our
Latin America and Europe, Middle East and Africa operating segments. Refer to
the heading "Liquidity, Capital Resources and Financial Position - Foreign
Exchange" below.
Net operating revenue growth rates are impacted by sales volume; price, product
and geographic mix; foreign currency fluctuations; and acquisitions and
divestitures. The size and timing of acquisitions and divestitures are not
consistent from period to period. Based on current spot rates and our hedging
coverage in place, we expect foreign currency fluctuations will have a slightly
favorable impact on our full year 2021 net operating revenues.
Gross Profit Margin
Gross profit margin is a ratio calculated by dividing gross profit by net
operating revenues. Management believes gross profit margin provides investors
with useful information related to the profitability of our business prior to
considering all of the operating costs incurred. Management uses this measure in
making financial, operating and planning decisions and in evaluating the
Company's performance.
Our gross profit margin increased to 62.6 percent for the three months ended
July 2, 2021, compared to 57.9 percent for the three months ended June 26, 2020.
Our gross profit margin increased to 61.9 percent for the six months ended
July 2, 2021, compared to 59.5 percent for the six months ended June 26, 2020.
These increases were primarily due to the impact of favorable channel and
package mix as a result of the gradual reopening of away-from-home channels in
the current year along with the impact of shelter-in-place and social distancing
requirements in the prior year.
Selling, General and Administrative Expenses
The following table sets forth the components of selling, general and
administrative expenses (in millions):
                                                          Three Months Ended                 Six Months Ended
                                                              July 2,     June 26,            July 2,     June 26,
                                                                 2021         2020               2021         2020
Stock-based compensation expense                     $       90       $      41          $     148    $      36
Advertising expenses                                      1,134             370              2,035        1,272
Selling and distribution expenses                           600             569              1,218        1,267
Other operating expenses                                  1,193           1,003              2,285        2,056

Selling, general and administrative expenses $ 3,017 $ 1,983 $ 5,686 $ 4,631



During the three and six months ended July 2, 2021, selling, general and
administrative expenses increased $1,034 million, or 52 percent, and increased
$1,055 million, or 23 percent, respectively, versus the prior year comparable
period. The increases were primarily due to increased marketing spending and an
increase in short-term incentive and stock-based compensation expense. The
increase in stock-based compensation expense in the current year was due to a
more favorable outlook for our financial performance in the current year, which
resulted in higher payout assumptions as compared to the prior year. During the
three and six months ended July 2, 2021, foreign currency exchange rate
fluctuations increased selling, general and administrative expenses by 7 percent
and 3 percent, respectively.
The increase in selling and distribution expenses during the three months ended
July 2, 2021 was primarily due to the continued reopening of Costa retail stores
in the United Kingdom, the gradual recovery in away-from-home channels in
certain markets, and foreign currency exchange rate fluctuations. The decrease
in selling and distribution expenses during the six months ended July 2, 2021
included the increase during the three months ended July 2, 2021, which was more
than offset by the larger negative impact that the COVID-19 pandemic had on
Costa retail stores in the United Kingdom and on North America away-from-home
channels during the first quarter of the current year as compared to the first
quarter of the prior year.
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As of July 2, 2021, we had $429 million of total unrecognized compensation cost
related to nonvested stock-based compensation awards granted under our plans,
which we expect to recognize over a weighted-average period of 2.2 years as
stock-based compensation expense. This expected cost does not include the impact
of any future stock-based compensation awards.
Other Operating Charges
Other operating charges incurred by operating segment and Corporate were as
follows (in millions):
                                                       Three Months Ended                  Six Months Ended
                                                         July 2,     June 26,                 July 2,     June 26,
                                                            2021         2020                    2021         2020
Europe, Middle East & Africa                       $       11    $       -          $      61         $       -
Latin America                                               -           10                 11                10
North America                                               8          110                 20               262
Asia Pacific                                                -            -                 13                 -
Global Ventures                                             -            -                  -                 -
Bottling Investments                                        -           13                  -                13
Corporate                                                 290           40                328                90
Total                                              $      309    $     173          $     433         $     375


During the three months ended July 2, 2021, the Company recorded other operating
charges of $309 million. These charges primarily consisted of $247 million
related to the remeasurement of our contingent consideration liability to fair
value in conjunction with the fairlife, LLC ("fairlife") acquisition, $29
million due to the Company's strategic realignment initiatives and $22 million
related to the Company's productivity and reinvestment program. In addition,
other operating charges included $7 million related to the restructuring of our
manufacturing operations in the United States and $4 million related to tax
litigation expense.
During the six months ended July 2, 2021, the Company recorded other operating
charges of $433 million. These charges primarily consisted of $251 million
related to the remeasurement of our contingent consideration liability to fair
value in conjunction with the fairlife acquisition, $122 million due to the
Company's strategic realignment initiatives and $40 million related to the
Company's productivity and reinvestment program. In addition, other operating
charges included $13 million related to tax litigation expense and $7 million
related to the restructuring of our manufacturing operations in the United
States.
During the three months ended June 26, 2020, the Company recorded other
operating charges of $173 million. These charges included an impairment charge
of $55 million related to a trademark in North America, which was primarily
driven by the impact of the COVID-19 pandemic, revised projections of future
operating results and a change in brand focus in the Company's portfolio. Also
included were charges of $35 million related to discontinuing the Odwalla juice
business and an impairment charge of $8 million related to the Odwalla
trademark. Other operating charges also included $22 million related to the
Company's productivity and reinvestment program, $18 million related to the
remeasurement of our contingent consideration liability to fair value in
conjunction with the fairlife acquisition and $12 million related to the
restructuring of our manufacturing operations in the United States.
During the six months ended June 26, 2020, the Company recorded other operating
charges of $375 million. These charges primarily consisted of an impairment
charge of $160 million related to the Odwalla trademark and charges of $35
million related to discontinuing the Odwalla juice business. These charges also
included an impairment charge of $55 million related to a trademark in North
America, which was primarily driven by the impact of the COVID-19 pandemic,
revised projections of future operating results and a change in brand focus in
the Company's portfolio. Other operating charges also included $61 million
related to the Company's productivity and reinvestment program, $29 million
related to the remeasurement of our contingent consideration liability to fair
value in conjunction with the fairlife acquisition and $12 million related to
the restructuring of our manufacturing operations in the United States.
Refer to Note 2 of Notes to Condensed Consolidated Financial Statements for
additional information on the fairlife acquisition. Refer to Note 8 of Notes to
Condensed Consolidated Financial Statements for additional information related
to the tax litigation. Refer to Note 12 of Notes to Condensed Consolidated
Financial Statements for additional information on the Company's strategic
realignment initiatives and productivity and reinvestment program. Refer to
Note 15 of Notes to Condensed Consolidated Financial Statements for additional
information on the impairment charges. Refer to Note 16 of Notes to Condensed
Consolidated Financial Statements for the impact these charges had on our
operating segments and Corporate.
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Operating Income and Operating Margin
Information about our operating income contribution by operating segment and
Corporate on a percentage basis is as follows:
                                       Three Months Ended                Six Months Ended
                                             July 2,   June 26,              July 2,   June 26,
                                                2021       2020                 2021       2020
Europe, Middle East & Africa                 37.9  %    36.1  %              34.2  %    38.4  %
Latin America                                22.5       25.4                 21.4       23.9
North America                                31.5       24.7                 30.4       20.1
Asia Pacific                                 25.4       32.9                 25.3       26.7
Global Ventures                               2.5       (5.1)                 1.8       (1.9)
Bottling Investments                          3.0        0.6                  4.0        1.7
Corporate                                   (22.8)     (14.6)               (17.1)      (8.9)
Total                                       100.0  %   100.0  %             100.0  %   100.0  %


Operating margin is a ratio calculated by dividing operating income by net
operating revenues. Management believes operating margin provides investors with
useful information related to the profitability of our business after
considering all of the operating costs incurred. Management uses this measure in
making financial, operating and planning decisions and in evaluating the
Company's performance.
Information about our operating margin on a consolidated basis and by operating
segment and Corporate is as follows:
                                       Three Months Ended                Six Months Ended
                                             July 2,   June 26,              July 2,   June 26,
                                                2021       2020                 2021       2020
Consolidated                                 29.8  %    27.7  %              30.0  %    27.7  %
Europe, Middle East & Africa                 60.9  %    63.0  %              58.8  %    61.8  %
Latin America                                63.5       66.8                 62.2       61.9
North America                                28.1       18.5                 27.6       15.9
Asia Pacific                                 56.8       61.1                 56.2       56.5
Global Ventures                              10.6      (34.5)                 7.9       (9.5)
Bottling Investments                          5.3        1.0                  6.4        2.6
Corporate                        *                   *             *                 *


* Calculation is not meaningful.
Three Months Ended July 2, 2021 versus Three Months Ended June 26, 2020
During the three months ended July 2, 2021, operating income was $3,016 million,
compared to $1,981 million during the three months ended June 26, 2020, an
increase of $1,035 million, or 52 percent. The increase was driven by
concentrate sales volume growth of 26 percent, favorable channel and package
mix, effective cost management, and a favorable foreign currency exchange rate
impact, partially offset by increased short-term incentive and stock-based
compensation expense, increased marketing spending, and higher other operating
charges.
During the three months ended July 2, 2021, fluctuations in foreign currency
exchange rates favorably impacted consolidated operating income by 5 percent due
to a weaker U.S. dollar compared to certain foreign currencies, including the
Mexican peso, Chinese yuan, Australian dollar and British pound sterling, which
had a favorable impact on our Latin America, Asia Pacific, Europe, Middle East
and Africa, and Global Ventures operating segments. The favorable impact of a
weaker U.S. dollar compared to the currencies listed above was partially offset
by the impact of a stronger U.S. dollar compared to certain other foreign
currencies, including the Argentine peso and Zimbabwean dollar, which had an
unfavorable impact on our Latin America and Europe, Middle East and Africa
operating segments. Refer to the heading "Liquidity, Capital Resources and
Financial Position - Foreign Exchange" below.
The Company's Europe, Middle East and Africa operating segment reported
operating income of $1,142 million and $715 million for the three months ended
July 2, 2021 and June 26, 2020, respectively. The increase in operating income
was primarily driven by a 41 percent increase in concentrate sales volume,
favorable channel and package mix, and a favorable foreign currency exchange
rate impact of 5 percent, partially offset by increased marketing spending and
higher other operating charges.
                                       45
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Latin America reported operating income of $678 million and $504 million for the
three months ended July 2, 2021 and June 26, 2020, respectively. The increase in
operating income was driven by concentrate sales volume growth of 29 percent;
favorable price, channel and package mix; a favorable foreign currency exchange
rate impact of 1 percent; and lower other operating charges, partially offset by
increased marketing spending.
Operating income for North America for the three months ended July 2, 2021 and
June 26, 2020 was $950 million and $489 million, respectively. The increase in
operating income was primarily driven by concentrate sales volume growth of 16
percent, favorable channel and package mix, a favorable foreign currency
exchange rate impact of 1 percent, and lower other operating charges, partially
offset by increased marketing spending.
Asia Pacific's operating income for the three months ended July 2, 2021 and
June 26, 2020 was $766 million and $652 million, respectively. The increase in
operating income was primarily driven by concentrate sales volume growth of 15
percent; favorable product, channel and package mix; and a favorable foreign
currency exchange rate impact of 7 percent, partially offset by increased
marketing spending.
Global Ventures' operating income for the three months ended July 2, 2021 was
$75 million, while the operating segment's operating loss for the three months
ended June 26, 2020 was $102 million. The change in operating income was
primarily driven by revenue growth as a result of the reopening of Costa retail
stores in the United Kingdom and a favorable foreign currency exchange rate
impact of 2 percent.
Bottling Investments' operating income for the three months ended July 2, 2021
and June 26, 2020 was $92 million and $12 million, respectively. The increase in
operating income was driven by volume growth of 25 percent; favorable price,
category and package mix; and lower other operating charges, partially offset by
an unfavorable foreign currency exchange rate impact of 147 percent.
Corporate's operating loss for the three months ended July 2, 2021 and June 26,
2020 was $687 million and $289 million, respectively. Operating loss in 2021
increased primarily as a result of increased marketing spending, higher
short-term incentive and stock-based compensation expense, and higher other
operating charges.
Six Months Ended July 2, 2021 versus Six Months Ended June 26, 2020
During the six months ended July 2, 2021, operating income was $5,738 million,
compared to $4,361 million during the six months ended June 26, 2020, an
increase of $1,377 million, or 32 percent. The increase was driven by
concentrate sales volume growth of 15 percent, favorable channel and package
mix, effective cost management, and a favorable foreign currency exchange rate
impact, partially offset by increased short-term incentive and stock-based
compensation expense, increased marketing spending and higher other operating
charges.
During the six months ended July 2, 2021, fluctuations in foreign currency
exchange rates favorably impacted consolidated operating income by 1 percent due
to a weaker U.S. dollar compared to certain foreign currencies, including the
Chinese yuan, Australian dollar, Mexican peso, euro and British pound sterling,
which had a favorable impact on our Asia Pacific, Latin America, Europe, Middle
East and Africa, and Global Ventures operating segments. The favorable impact of
a weaker U.S. dollar compared to the currencies listed above was partially
offset by the impact of a stronger U.S. dollar compared to certain other foreign
currencies, including the Brazilian real, Argentine peso and Turkish lira, which
had an unfavorable impact on our Latin America and Europe, Middle East and
Africa operating segments. Refer to the heading "Liquidity, Capital Resources
and Financial Position - Foreign Exchange" below.
The Company's Europe, Middle East and Africa operating segment reported
operating income of $1,962 million and $1,675 million for the six months ended
July 2, 2021 and June 26, 2020, respectively. The increase in operating income
was primarily driven by concentrate sales volume growth of 18 percent, favorable
channel and package mix, and a favorable foreign currency exchange rate impact
of 2 percent, partially offset by increased marketing spending and higher other
operating charges.
Latin America reported operating income of $1,230 million and $1,043 million for
the six months ended July 2, 2021 and June 26, 2020, respectively. The increase
in operating income was driven by concentrate sales volume growth of 14 percent
and favorable price, channel and package mix, partially offset by increased
marketing spending and an unfavorable foreign currency exchange rate impact of 5
percent.
Operating income for North America for the six months ended July 2, 2021 and
June 26, 2020 was $1,742 million and $876 million, respectively. The increase in
operating income was primarily driven by concentrate sales volume growth of 8
percent, favorable channel and package mix, a favorable foreign currency
exchange rate impact of 1 percent, effective cost management and lower other
operating charges, partially offset by increased marketing spending.
Asia Pacific's operating income for the six months ended July 2, 2021 and
June 26, 2020 was $1,452 million and $1,163 million, respectively. The increase
in operating income was primarily driven by concentrate sales volume growth of
                                       46
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17 percent; favorable product, channel and package mix; and a favorable foreign
currency exchange rate impact of 8 percent, partially offset by increased
marketing spending and higher other operating charges.
Global Ventures' operating income for the six months ended July 2, 2021 was $101
million, while the operating segment's operating loss for the six months ended
June 26, 2020 was $83 million. The change in operating income was primarily
driven by revenue growth as a result of the reopening of Costa retail stores in
the United Kingdom and a favorable foreign currency exchange rate impact of 4
percent.
Bottling Investments' operating income for the six months ended July 2, 2021 and
June 26, 2020 was $233 million and $75 million, respectively. The increase in
operating income was driven by volume growth of 18 percent; favorable price,
category and package mix; and lower other operating charges, partially offset by
an unfavorable foreign currency exchange rate impact of 42 percent.
Corporate's operating loss for the six months ended July 2, 2021 and June 26,
2020 was $982 million and $388 million, respectively. Operating loss in 2021
increased primarily as a result of higher short-term incentive and stock-based
compensation expense, increased marketing spending and higher other operating
charges.
Based on current spot rates and our hedging coverage in place, we expect foreign
currency fluctuations will have a slightly favorable impact on operating income
through the end of the year.
Interest Income
During the three months ended July 2, 2021, interest income was $71 million,
compared to $100 million during the three months ended June 26, 2020, a decrease
of $29 million, or 29 percent. During the six months ended July 2, 2021,
interest income was $137 million, compared to $212 million during the six months
ended June 26, 2020, a decrease of $75 million, or 36 percent. These decreases
were primarily driven by lower returns in certain of our international
locations.
Interest Expense
During the three months ended July 2, 2021, interest expense was $780 million,
compared to $274 million during the three months ended June 26, 2020, an
increase of $506 million, or 184 percent. During the six months ended July 2,
2021, interest expense was $1,222 million, compared to $467 million during the
six months ended June 26, 2020, an increase of $755 million, or 162 percent. The
increases for the three and six months ended July 2, 2021 were primarily due to
charges of $592 million and $650 million, respectively, associated with the
extinguishment of long-term debt. The increases in interest expense were also
driven by higher average long-term debt balances, partially offset by lower
short-term U.S. interest rates and balances. Refer to Note 7 of Notes to
Condensed Consolidated Financial Statements.
Equity Income (Loss) - Net
Three Months Ended July 2, 2021 versus Three Months Ended June 26, 2020
During the three months ended July 2, 2021, equity income was $402 million,
compared to equity income of $176 million during the three months ended June 26,
2020, an increase of $226 million, or 128 percent. This increase primarily
reflects the impact of more favorable operating results reported by most of our
equity method investees in the current year, as prior year results were more
negatively impacted by the COVID-19 pandemic, along with a favorable impact from
fluctuations in foreign currency exchange rates. In addition, the Company
recorded net charges of $60 million and $63 million in the line item equity
income (loss) - net during the three months ended July 2, 2021 and June 26,
2020, respectively. These amounts represent the Company's proportionate share of
significant operating and nonoperating items recorded by certain of our equity
method investees.
Six Months Ended July 2, 2021 versus Six Months Ended June 26, 2020
During the six months ended July 2, 2021, equity income was $681 million,
compared to equity income of $343 million during the six months ended June 26,
2020, an increase of $338 million, or 98 percent. This increase primarily
reflects the impact of more favorable operating results reported by most of our
equity method investees in the current year, as prior year results were more
negatively impacted by the COVID-19 pandemic, along with a favorable foreign
currency exchange rate impact. In addition, the Company recorded net charges of
$23 million and $101 million in the line item equity income (loss) - net during
the six months ended July 2, 2021 and June 26, 2020, respectively. These amounts
represent the Company's proportionate share of significant operating and
nonoperating items recorded by certain of our equity method investees.
Other Income (Loss) - Net
Three Months Ended July 2, 2021 versus Three Months Ended June 26, 2020
Other income (loss) - net includes, among other things, dividend income; gains
and losses related to the disposal of property, plant and equipment; gains and
losses related to acquisitions and divestitures; non-service cost components of
net periodic benefit cost (income) for pension and other postretirement benefit
plans; other charges and credits related to pension and other
                                       47
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postretirement benefit plans; realized and unrealized gains and losses on equity
securities and trading debt securities; realized gains and losses on
available-for-sale debt securities; other-than-temporary impairment charges; and
net foreign currency exchange gains and losses. The foreign currency exchange
gains and losses are primarily the result of the remeasurement of monetary
assets and liabilities from certain currencies into functional currencies. The
effects of the remeasurement of these assets and liabilities are partially
offset by the impact of our economic hedging program for certain exposures on
our consolidated balance sheet. Refer to Note 6 of Notes to Condensed
Consolidated Financial Statements.
During the three months ended July 2, 2021, other income (loss) - net was income
of $909 million. The Company recognized a net gain of $695 million related to
the sale of our ownership interest in Coca-Cola Amatil Limited ("CCA"), an
equity method investee, to Coca-Cola Europacific Partners plc ("CCEP"), also an
equity method investee. Additionally, the Company recognized a net gain of
$203 million related to realized and unrealized gains and losses on equity
securities and trading debt securities as well as realized gains and losses on
available-for-sale debt securities. The Company also recorded pension benefit
plan settlement charges of $29 million related to its strategic realignment
initiatives. Other income (loss) - net also included income of $73 million
related to the non-service cost components of net periodic benefit cost
(income), dividend income of $29 million and net foreign currency exchange
losses of $37 million.
During the three months ended June 26, 2020, other income (loss) - net was
income of $214 million. The Company recognized a net gain of $247 million
related to realized and unrealized gains and losses on equity securities and
trading debt securities as well as realized gains and losses on
available-for-sale debt securities. The Company also recorded an
other-than-temporary impairment charge of $38 million related to one of our
equity method investees in Latin America and a charge of $19 million related to
asset write-offs associated with the restructuring of our manufacturing
operations in the United States. Other income (loss) - net also included income
of $42 million related to the non-service cost components of net periodic
benefit cost (income), dividend income of $35 million and net foreign currency
exchange losses of $49 million.
None of the other items included in other income (loss) - net for the three
months ended July 2, 2021 and June 26, 2020 was individually significant. Refer
to Note 2 of Notes to Condensed Consolidated Financial Statements for additional
information on the sale of our ownership interest in CCA. Refer to Note 4 of
Notes to Condensed Consolidated Financial Statements for additional information
on equity and debt securities. Refer to Note 12 of Notes to Condensed
Consolidated Financial Statements for additional information on the strategic
realignment initiatives. Refer to Note 13 of Notes to Condensed Consolidated
Financial Statements for additional information on net periodic benefit cost
(income). Refer to Note 15 of Notes to Condensed Consolidated Financial
Statements for additional information on the impairment charge. Refer to Note 16
of Notes to Condensed Consolidated Financial Statements for the impact that
certain of these items had on our operating segments and Corporate.
Six Months Ended July 2, 2021 versus Six Months Ended June 26, 2020
During the six months ended July 2, 2021, other income (loss) - net was income
of $1,047 million. The Company recognized a net gain of $695 million related to
the sale of our ownership interest in CCA, an equity method investee, to CCEP,
also an equity method investee. Additionally, the Company recognized a net gain
of $336 million related to realized and unrealized gains and losses on equity
securities and trading debt securities as well as realized gains and losses on
available-for-sale debt securities. The Company also recorded pension benefit
plan settlement charges of $83 million related to its strategic realignment
initiatives. Other income (loss) - net also included income of $133 million
related to the non-service cost components of net periodic benefit cost
(income), dividend income of $39 million and net foreign currency exchange
losses of $46 million.
During the six months ended June 26, 2020, other income (loss) - net was income
of $758 million. The Company recognized a gain of $902 million in conjunction
with the fairlife acquisition, which resulted from the remeasurement of our
previously held equity interest in fairlife to fair value, and a gain of $18
million related to the sale of a portion of our ownership interest in one of our
equity method investments. These gains were partially offset by an
other-than-temporary impairment charge of $38 million related to one of our
equity method investees in Latin America, a charge of $19 million related to
asset write-offs associated with the restructuring of our manufacturing
operations in the United States, a net loss of $144 million related to realized
and unrealized gains and losses on equity securities and trading debt securities
as well as realized gains and losses on available-for-sale debt securities, and
a net loss of $55 million related to economic hedging activities. Other income
(loss) - net also included income of $85 million related to the non-service cost
components of net periodic benefit cost (income), dividend income of $42 million
and net foreign currency exchange losses of $33 million.
None of the other items included in other income (loss) - net for the six months
ended July 2, 2021 and June 26, 2020 was individually significant. Refer to
Note 2 of Notes to Condensed Consolidated Financial Statements for additional
information on the sale of our ownership interest in CCA and the fairlife
acquisition. Refer to Note 4 of Notes to Condensed Consolidated Financial
Statements for additional information on equity and debt securities. Refer to
Note 6 of Notes to Condensed Consolidated Financial Statements for additional
information on economic hedging activities. Refer to Note 12 of Notes to
Condensed Consolidated Financial Statements for additional information on the
strategic realignment initiatives. Refer to
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Note 13 of Notes to Condensed Consolidated Financial Statements for additional
information on net periodic benefit cost (income). Refer to Note 15 of Notes to
Condensed Consolidated Financial Statements for additional information on the
impairment charge. Refer to Note 16 of Notes to Condensed Consolidated Financial
Statements for the impact that certain of these items had on our operating
segments and Corporate.
Income Taxes
The Company recorded income taxes of $994 million (27.5 percent effective tax
rate) and $438 million (19.9 percent effective tax rate) during the three months
ended July 2, 2021 and June 26, 2020, respectively. The Company recorded income
taxes of $1,502 million (23.5 percent effective tax rate) and $653 million (12.5
percent effective tax rate) during the six months ended July 2, 2021 and
June 26, 2020, respectively.
The Company's effective tax rates for the three and six months ended July 2,
2021 and June 26, 2020 vary from the statutory U.S. federal income tax rate of
21.0 percent primarily due to the tax impact of significant operating and
nonoperating items, as described in Note 11 of Notes to Condensed Consolidated
Financial Statements, along with the tax benefits of having significant
operations outside the United States and significant earnings generated in
investments accounted for under the equity method, both of which are generally
taxed at rates lower than the statutory U.S. rate.
The Company's effective tax rates for the three and six months ended July 2,
2021 included $183 million and $176 million, respectively, of net tax expense
related to various discrete tax items, primarily changes in tax laws in certain
foreign jurisdictions.
The Company's effective tax rates for the three and six months ended June 26,
2020 included $11 million and $99 million of net tax benefits, respectively,
associated with various discrete tax items, including return to provision
adjustments, excess tax benefits associated with the Company's stock-based
compensation arrangements, and net tax charges for changes to our uncertain tax
positions, including interest and penalties. The Company's effective tax rate
for the six months ended June 26, 2020 also included a tax benefit of
$54 million associated with a change in tax law in a foreign jurisdiction as
well as a tax benefit of $40 million associated with the gain recorded upon the
acquisition of the remaining interest in fairlife. Refer to Note 2 of Notes to
Condensed Consolidated Financial Statements for additional information on the
fairlife acquisition.
On November 18, 2020, the U.S. Tax Court ("Tax Court") issued an opinion
("Opinion") regarding the Company's 2015 litigation with the U.S. Internal
Revenue Service ("IRS") involving transfer pricing tax adjustments in which the
Tax Court predominantly sided with the IRS. The Company strongly disagrees with
the Opinion and intends to vigorously defend its position. Refer to Note 8 of
Notes to Condensed Consolidated Financial Statements for additional information
on the litigation.
At the end of each interim period, we make our best estimate of the effective
tax rate expected to be applicable for the full fiscal year. This estimate
reflects, among other items, our best estimate of operating results and foreign
currency exchange rates. Based on current tax laws, the Company's effective tax
rate in 2021 is expected to be 19.1 percent before considering the potential
impact of any significant operating and nonoperating items that may affect our
effective tax rate. This rate does not include the impact of the ongoing tax
litigation with the IRS, if the Company were not to prevail.
              LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION
We believe our ability to generate cash flows from operating activities is one
of the fundamental strengths of our business. Refer to the heading "Cash Flows
from Operating Activities" below. The Company does not typically raise capital
through the issuance of stock. Instead, we use debt financing to lower our
overall cost of capital and increase our return on shareowners' equity. Refer to
the heading "Cash Flows from Financing Activities" below. We have a history of
borrowing funds both domestically and internationally at reasonable interest
rates, and we expect to be able to continue to borrow funds at reasonable rates
over the long term. Our debt financing also includes the use of a commercial
paper program. We currently have the ability to borrow funds in this market at
levels that are consistent with our debt financing strategy, and we expect to
continue to be able to do so in the future.
The Company reviews its optimal mix of short-term and long-term debt regularly
and, as a result of this review, in 2021, we issued U.S. dollar- and
euro-denominated long-term debt of $6.0 billion and €3.2 billion, respectively,
across various maturities. We used a portion of the proceeds from the long-term
debt issuances to extinguish certain tranches of our previously issued long-term
debt. Refer to Note 7 of Notes to Condensed Consolidated Financial
Statements for additional information on the debt issuances and extinguishments.
The Company's cash, cash equivalents, short-term investments and marketable
securities totaled $13.0 billion as of July 2, 2021. In addition to these funds,
our commercial paper program and our ability to issue long-term debt, we had
$6.5 billion in unused lines of credit for general corporate purposes as of
July 2, 2021. These backup lines of credit expire at various times from 2021
through 2025.
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While uncertainty caused by the COVID-19 pandemic remains, we expect to continue
to see improvements in our business as vaccines become more widely available.
The timing and availability of vaccines will be different around the world, and
therefore we believe the pace of the recovery will vary by geography depending
on vaccine availability, rates of vaccination and the effectiveness of vaccines
against existing and new variants of the virus, along with other macroeconomic
factors. We will remain flexible so that we can adjust to uncertainties while we
continue to move forward on the initiatives we implemented to emerge stronger
from the COVID-19 pandemic. In 2021, we are increasing marketing spending behind
our brands to drive increased net operating revenues. We expect the return on
that spending to become more favorable as mobility increases and away-from-home
channels regain momentum. While many of the operating expenses that were
significantly reduced in 2020 are increasing in 2021, we will continue to focus
on cash flow generation. Our current capital allocation priorities are focused
on investing wisely to support our business operations and continuing to grow
our dividend payment. We currently expect 2021 capital expenditures to be
approximately $1.5 billion. In addition, we do not intend to repurchase shares
under our Board of Directors' authorized plan during the year ending December
31, 2021, and we do not intend to change our approach toward paying dividends.
We are currently in litigation with the IRS for tax years 2007 through 2009. On
November 18, 2020, the Tax Court issued the Opinion in which it predominantly
sided with the IRS; however, a final decision is still pending and the timing of
such decision is not currently known. The Company strongly disagrees with the
IRS' positions and the portions of the Opinion affirming such positions and
intends to vigorously defend our positions utilizing every available avenue of
appeal. While the Company believes that it is more likely than not that we will
ultimately prevail in this litigation upon appeal, it is possible that all, or
some portion of, the adjustments proposed by the IRS and sustained by the Tax
Court could ultimately be upheld. In the event that all of the adjustments
proposed by the IRS are ultimately upheld for tax years 2007 through 2009 and
the IRS, with the consent of the federal court, were to decide to apply the
underlying methodology ("Tax Court Methodology") to the subsequent years up to
and including 2020, the Company currently estimates that the potential aggregate
incremental tax and interest liability could be approximately $12 billion.
Additional income tax and interest would continue to accrue until the time any
such potential liability, or portion thereof, were to be paid. The Company
estimates the impact of the continued application of the Tax Court Methodology
for the six months ended July 2, 2021 would increase the potential aggregate
incremental tax and interest liability by approximately $500 million. Once the
Tax Court renders a final decision, the Company will have 90 days to file a
notice of appeal and pay the portion of the potential aggregate incremental tax
and interest liability related to the 2007 through 2009 litigation period, which
we currently estimate to be approximately $4.8 billion (including interest
accrued through July 2, 2021), plus any additional interest accrued through the
time of payment. Refer to Note 8 of Notes to Condensed Consolidated Financial
Statements for additional information on the tax litigation.
While we believe it is more likely than not that we will prevail in the tax
litigation discussed above, we are confident that, between our ability to
generate cash flows from operating activities and our ability to borrow funds at
reasonable interest rates, we can manage the range of possible outcomes in the
final resolution of the matter.
Based on all of the aforementioned factors, the Company believes its current
liquidity position is strong and will continue to be sufficient to fund our
operating activities and cash commitments for investing and financing activities
for the foreseeable future.
Cash Flows from Operating Activities
As part of our continued efforts to improve our working capital efficiency, we
have worked with our suppliers over the past several years to revisit terms and
conditions, including the extension of payment terms. Our current payment terms
with the majority of our suppliers are 120 days. Additionally, two global
financial institutions offer a voluntary supply chain finance ("SCF") program
which enables our suppliers, at their sole discretion, to sell their receivables
from the Company to these financial institutions on a non-recourse basis at a
rate that leverages our credit rating and thus may be more beneficial to them.
The SCF program is available to suppliers of goods and services included in cost
of goods sold as well as suppliers of goods and services included in selling,
general and administrative expenses in our consolidated statement of income. The
Company and our suppliers agree on contractual terms for the goods and services
we procure, including prices, quantities and payment terms, regardless of
whether the supplier elects to participate in the SCF program. The suppliers
sell goods or services, as applicable, to the Company and issue the associated
invoices to the Company based on the agreed-upon contractual terms. Then, if
they are participating in the SCF program, our suppliers, at their sole
discretion, determine which invoices, if any, they want to sell to the financial
institutions. Our suppliers' voluntary inclusion of invoices in the SCF program
has no bearing on our payment terms. No guarantees are provided by the Company
or any of our subsidiaries under the SCF program. We have no economic interest
in a supplier's decision to participate in the SCF program, and we have no
direct financial relationship with the financial institutions, as it relates to
the SCF program. Accordingly, amounts due to our suppliers that elected to
participate in the SCF program are included in the line item accounts payable
and accrued expenses in our consolidated balance sheet. All activity related to
amounts due to suppliers that elected to participate in the SCF program is
reflected within the operating activities section of our consolidated statement
of cash flows. We have been informed by the financial institutions that as of
July 2, 2021 and December 31, 2020, suppliers had elected to sell $774 million
and $703 million, respectively, of our outstanding payment obligations to the
financial institutions. The amounts settled through the SCF program were
                                       50
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$1,475 million and $1,375 million for the six months ended July 2, 2021 and
June 26, 2020, respectively. We do not believe there is a risk that our payment
terms will be shortened in the near future, and we do not currently expect our
net cash provided by operating activities to be significantly impacted by
additional extensions of payment terms in the foreseeable future.
In the fourth quarter of 2020, the Company started a trade accounts receivable
factoring program in certain countries. Under this program, we can elect to sell
trade accounts receivables to unaffiliated financial institutions at a discount.
In these factoring arrangements, for ease of administration, the Company
collects customer payments related to the factored receivables and remits those
payments to the financial institutions. The Company sold $2,942 million of trade
accounts receivables under this program during the six months ended July 2,
2021, and the costs of factoring such receivables were not material. The Company
classifies the cash received from the financial institutions within the
operating activities section of our consolidated statement of cash flows.
Net cash provided by operating activities for the six months ended July 2, 2021
and June 26, 2020 was $5,525 million and $2,786 million, respectively, an
increase of $2,739 million, or 98 percent. This increase was primarily driven by
increased operating income, a benefit from our trade accounts receivable
factoring program, lower short-term incentive payments in 2021 as a result of
the impact of the COVID-19 pandemic on our operating performance in 2020, lower
payments of year-end marketing accruals due to lower spending in 2020 as a
result of the COVID-19 pandemic, lower current year prepayments to customers and
the impact of payment term extensions with certain of our suppliers throughout
2020. These items were partially offset by higher restructuring, tax and
interest payments in the current year. Refer to Note 12 of Notes to Condensed
Consolidated Financial Statements for additional information on our
restructuring initiatives.
Cash Flows from Investing Activities
Net cash provided by investing activities for the six months ended July 2, 2021
was $1,753 million and net cash used in investing activities for the six months
ended June 26, 2020 was $6,967 million.
Purchases of Investments and Proceeds from Disposals of Investments
During the six months ended July 2, 2021, purchases of investments were $3,431
million and proceeds from disposals of investments were $3,811 million,
resulting in a net cash inflow of $380 million. During the six months ended
June 26, 2020, purchases of investments were $8,294 million and proceeds from
disposals of investments were $2,649 million, resulting in a net cash outflow of
$5,645 million. This activity primarily represents the purchases of, and
proceeds from the disposals of, investments in marketable securities and
short-term investments that were made as part of the Company's overall cash
management strategy. Also included in this activity are purchases of, and
proceeds from the disposals of, investments held by our captive insurance
companies. Refer to Note 4 of Notes to Condensed Consolidated Financial
Statements for additional information.
Acquisitions of Businesses, Equity Method Investments and Nonmarketable
Securities
During the six months ended July 2, 2021, the Company's acquisitions of
businesses, equity method investments and nonmarketable securities totaled
$11 million. During the six months ended June 26, 2020, the Company's
acquisitions of businesses, equity method investments and nonmarketable
securities totaled $984 million, which primarily related to the acquisition of
the remaining ownership interest in fairlife. Refer to Note 2 of Notes to
Condensed Consolidated Financial Statements for additional information.
Proceeds from Disposals of Businesses, Equity Method Investments and
Nonmarketable Securities
During the six months ended July 2, 2021, proceeds from disposals of businesses,
equity method investments and nonmarketable securities were $1,765 million,
which primarily related to the sale of our ownership interest in CCA. During the
six months ended June 26, 2020, proceeds from disposals of businesses, equity
method investments and nonmarketable securities were $46 million, which
primarily related to the sale of a portion of our ownership interest in one of
our equity method investments. Refer to Note 2 of Notes to Condensed
Consolidated Financial Statements for additional information.
Purchases of Property, Plant and Equipment
Purchases of property, plant and equipment for the six months ended July 2, 2021
and June 26, 2020 were $450 million and $536 million, respectively.
Cash Flows from Financing Activities
Net cash used in financing activities during the six months ended July 2, 2021
was $4,962 million and net cash provided by financing activities during the six
months ended June 26, 2020 was $8,045 million.
Debt Financing
Issuances and payments of debt included both short-term and long-term financing
activities. During the six months ended July 2, 2021, the Company had issuances
of debt of $10,752 million, which included $1,127 million of issuances related
to
                                       51
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commercial paper and short-term debt with maturities greater than 90 days and
long-term debt issuances of $9,625 million, net of related discounts and
issuance costs.
The Company made payments of debt of $11,957 million during the six months ended
July 2, 2021, which included $1,280 million of payments of commercial paper and
short-term debt with maturities greater than 90 days, $170 million of payments
of commercial paper and short-term debt with maturities of 90 days or less, and
net payments of long-term debt of $10,507 million. The payments of long-term
debt included payments of $6,500 million and €2,430 million related to the
extinguishment of long-term debt. Refer to Note 7 of Notes to Condensed
Consolidated Financial Statements.
Issuances of Stock
During the six months ended July 2, 2021, the Company received cash proceeds
from issuances of stock of $342 million, a decrease of $102 million when
compared to cash proceeds from issuances of stock of $444 million during the six
months ended June 26, 2020. The issuances of stock during the six months ended
July 2, 2021 and June 26, 2020 were related to the exercise of stock options by
employees.
Share Repurchases
During the six months ended July 2, 2021, the Company did not repurchase common
stock under the share repurchase plan authorized by our Board of Directors. The
Company's treasury stock activity includes shares surrendered to the Company to
pay the exercise price and/or to satisfy tax withholding obligations in
connection with so-called stock swap exercises of employee stock options and/or
the vesting of restricted stock issued to employees. The Company's treasury
stock activity during the six months ended July 2, 2021 resulted in a cash
outflow of $104 million.
Dividends
During the six months ended July 2, 2021 and June 26, 2020, the Company paid
dividends of $3,623 million and $1,761 million, respectively. As a result of
timing, the Company paid the second quarter dividend in 2021 prior to the end of
the reporting period and paid the second quarter dividend in 2020 subsequent to
the end of the reporting period.
Our Board of Directors approved the Company's regular quarterly dividend of
$0.42 per share at its July 2021 meeting. This dividend is payable on October 1,
2021 to shareowners of record as of the close of business on September 15, 2021.
Foreign Exchange
Our international operations are subject to certain opportunities and risks,
including currency fluctuations and governmental actions. We closely monitor our
operations in each country and seek to adopt appropriate strategies that are
responsive to changing economic and political environments as well as to
fluctuations in currencies.
Our Company conducts business in more than 200 countries and territories. Due to
the geographic diversity of our operations, weakness in some currencies may be
offset by strength in others. Our foreign currency management program is
designed to mitigate, over time, a portion of the potentially unfavorable impact
of exchange rate changes on our net income and earnings per share. Taking into
account the effects of our hedging activities, the impact of fluctuations in
foreign currency exchange rates increased our operating income for the three and
six months ended July 2, 2021 by 5 percent and 1 percent, respectively.
Based on current spot rates and our hedging coverage in place, we expect foreign
currency fluctuations will have a slightly favorable impact on operating income
and cash flows from operating activities through the end of the year.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have no material changes to the disclosures on this matter made in our Annual
Report on Form 10-K for the year ended December 31, 2020.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company, under the supervision and with the participation of its management,
including the Chief Executive Officer and the Chief Financial Officer, evaluated
the effectiveness of the design and operation of the Company's "disclosure
controls and procedures" (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended ("Exchange Act")) as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer concluded that the Company's disclosure controls
and procedures were effective as of July 2, 2021.
Changes in Internal Control Over Financial Reporting
In April 2021, we implemented a new financial book of record with the upgrade of
our Enterprise Resource Planning ("ERP") system to SAP S/4HANA. Along with this
upgrade, we have made changes to our internal controls over financial reporting
to address processes impacted by the ERP system upgrade. Other than the
implementation of a new financial book of record and
                                       52
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the upgrade of our ERP system, there have been no changes in the Company's
internal control over financial reporting during the quarter ended July 2, 2021
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
Additional system upgrades of our core supply chain systems are planned to be
implemented in a phased approach through 2022 and will result in further changes
to our internal controls over financial reporting. As changes occur, we will
evaluate quarterly whether such changes materially affect our internal control
over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
Information regarding reportable legal proceedings is contained in Part I, "Item
3. Legal Proceedings" in our Annual Report on Form 10-K for the year ended
December 31, 2020. The following updates and restates the description of the
previously reported U.S. Federal Income Tax Dispute matter.
U.S. Federal Income Tax Dispute
On September 17, 2015, the Company received a Statutory Notice of Deficiency
("Notice") from the U.S. Internal Revenue Service ("IRS") seeking approximately
$3.3 billion of additional federal income tax for years 2007 through 2009. In
the Notice, the IRS stated its intent to reallocate over $9 billion of income to
the U.S. parent company from certain of its foreign affiliates that the U.S.
parent company licensed to manufacture, distribute, sell, market and promote its
products in certain non-U.S. markets.
The Notice concerned the Company's transfer pricing between its U.S. parent
company and certain of its foreign affiliates. IRS rules governing transfer
pricing require arm's-length pricing of transactions between related parties
such as the Company's U.S. parent and its foreign affiliates.
To resolve the same transfer pricing issue for the tax years 1987 through 1995,
the Company and the IRS had agreed in 1996 on an arm's-length methodology for
determining the amount of U.S. taxable income that the U.S. parent company would
report as compensation from its foreign licensees. The Company and the IRS
memorialized this accord in a closing agreement resolving that dispute ("Closing
Agreement"). The Closing Agreement provided that, absent a change in material
facts or circumstances or relevant federal tax law, in calculating the Company's
income taxes going forward, the Company would not be assessed penalties by the
IRS for using the agreed-upon tax calculation methodology that the Company and
the IRS agreed would be used for the 1987 through 1995 tax years.
The IRS audited and confirmed the Company's compliance with the agreed-upon
Closing Agreement methodology in five successive audit cycles for tax years 1996
through 2006.
The September 17, 2015 Notice from the IRS retroactively rejected the previously
agreed-upon methodology for the 2007 through 2009 tax years, in favor of an
entirely different methodology, without prior notice to the Company. Using the
new tax calculation methodology, the IRS reallocated over $9 billion of income
to the U.S. parent company from its foreign licensees for tax years 2007 through
2009. Consistent with the Closing Agreement, the IRS did not assert penalties,
and it has yet to do so.
The IRS designated the Company's matter for litigation on October 15, 2015.
Litigation designation is an IRS determination that forecloses to a company any
and all alternative means for resolution of a tax dispute. As a result of the
IRS' designation of the Company's matter for litigation, the Company was forced
to either accept the IRS' newly imposed tax assessment and pay the full amount
of the asserted tax or litigate the matter in the federal courts. The matter
remains subject to the IRS' litigation designation, preventing the Company from
any attempt to settle or otherwise mutually resolve the matter with the IRS.
The Company consequently initiated litigation by filing a petition in the U.S.
Tax Court ("Tax Court") in December 2015, challenging the tax adjustments
enumerated in the Notice.
Prior to trial, the IRS increased its transfer pricing adjustment by $385
million, resulting in an additional tax adjustment of $135 million. The Company
obtained a summary judgment in its favor on a different matter related to
Mexican foreign tax credits, which thereafter effectively reduced the IRS'
potential tax adjustment by approximately $138 million.
The trial was held in the Tax Court from March through May 2018, and final
post-trial briefs were filed and exchanged in April 2019.
On November 18, 2020, the Tax Court issued an opinion ("Opinion") in which it
predominantly sided with the IRS but agreed with the Company that dividends
previously paid by the foreign licensees to the U.S. parent company in reliance
upon the Closing Agreement should continue to be allowed to offset royalties,
including those that would become payable to the Company in accordance with the
Opinion. The Tax Court reserved ruling on the effect of Brazilian legal
restrictions on the payment of royalties by the Company's licensee in Brazil
until after the Tax Court issues its opinion in the separate case of
                                       53
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3M Co. & Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013).
Once the Tax Court issues its opinion in 3M Co. & Subs. v. Commissioner, the
Company expects the Tax Court thereafter to render another opinion, and
ultimately a final decision, in the Company's case.
The Company believes that the IRS and the Tax Court misinterpreted and
misapplied the applicable regulations in reallocating income earned by the
Company's foreign licensees to increase the Company's U.S. tax. Moreover, the
Company believes that the retroactive imposition of such tax liability using a
calculation methodology different from that previously agreed upon by the IRS
and the Company, and audited by the IRS for over a decade, is unconstitutional.
The Company intends to assert its claims on appeal and vigorously defend its
position.
In determining the amount of tax reserve to be recorded as of December 31, 2020,
the Company completed the required two-step evaluation process prescribed by
Accounting Standards Codification 740, Accounting for Income Taxes. In doing so,
we consulted with outside advisors and we reviewed and considered relevant laws,
rules, and regulations, including, though not limited to, the Opinion and
relevant caselaw. We also considered our intention to vigorously defend our
positions and assert our various well-founded legal claims via every available
avenue of appeal. We concluded, based on the technical and legal merits of the
Company's tax positions, that it is more likely than not the Company's tax
positions will ultimately be sustained on appeal. In addition, we considered a
number of alternative transfer pricing methodologies, including the methodology
asserted by the IRS and affirmed in the Opinion ("Tax Court Methodology"), that
could be applied by the courts upon final resolution of the litigation. Based on
the required probability analysis, we determined the methodologies we believe
the federal courts could ultimately order to be used in calculating the
Company's tax. As a result of this analysis, we recorded a tax reserve of
$438 million during the year ended December 31, 2020 related to the application
of the resulting methodologies as well as the different tax treatment applicable
to dividends originally paid to the U.S. parent company by its foreign
licensees, in reliance upon the Closing Agreement, that would be recharacterized
as royalties in accordance with the Opinion and the Company's analysis.
The Company's conclusion that it is more likely than not the Company's tax
positions will ultimately be sustained on appeal is unchanged as of July 2,
2021. However, we updated our calculation of the methodologies we believe the
federal courts could ultimately order to be used in calculating the Company's
tax. As a result of the application of the required probability analysis to
these updated calculations and the accrual of interest through the current
reporting period, we updated our tax reserve as of July 2, 2021 to $395 million.
While the Company strongly disagrees with the IRS' positions and the portions of
the Opinion affirming such positions, it is possible that some portion or all of
the adjustment proposed by the IRS and sustained by the Tax Court could
ultimately be upheld. In that event, the Company would likely be subject to
significant additional liabilities for tax years 2007 through 2009, and
potentially also for subsequent years, which could have a material adverse
impact on the Company's financial position, results of operations and cash
flows.
The Company calculated the potential impact of applying the Tax Court
Methodology to reallocate income from foreign licensees potentially covered
within the scope of the Opinion, assuming such methodology were to be ultimately
upheld by the courts, and the IRS were to decide to apply that methodology to
subsequent years, with consent of the federal courts. This impact would include
taxes and interest accrued through December 31, 2020 for the 2007 through 2009
litigated tax years and for subsequent tax years from 2010 to 2020. The
calculations incorporated the estimated impact of correlative adjustments to the
previously accrued transition tax payable under the 2017 Tax Cuts and Jobs Act.
The Company currently estimates that the potential aggregate incremental tax and
interest liability could be approximately $12 billion as of December 31, 2020.
Additional income tax and interest would continue to accrue until the time any
such potential liability, or portion thereof, were to be paid. The Company
estimates the impact of the continued application of the Tax Court Methodology
for the three and six months ended July 2, 2021 would increase the potential
aggregate incremental tax and interest liability by approximately $250 million
and $500 million, respectively. Additionally, we currently project the continued
application of the Tax Court Methodology in future years, assuming similar facts
and circumstances as of December 31, 2020, would result in an incremental annual
tax liability that would increase the Company's effective tax rate by
approximately 3.5 percent.
The Company does not know when the Tax Court will issue its opinion regarding
the effect of Brazilian legal restrictions on the payment of royalties by the
Company's licensee in Brazil for the 2007 through 2009 tax years. After the Tax
Court issues its opinion on the Company's Brazilian licensee, the Company and
the IRS will be provided time to agree on the tax impact, if any, of both
opinions, after which the Tax Court would render a final decision in the case.
The Company will have 90 days thereafter to file a notice of appeal to the U.S.
Court of Appeals for the Eleventh Circuit and pay the tax liability and interest
related to the 2007 through 2009 tax period. The Company currently estimates
that the payment to be made at that time related to the 2007 through 2009 tax
period, which is included in the above estimate of the potential aggregate
incremental tax and interest liability, would be approximately $4.8 billion
(including interest accrued through July 2, 2021), plus any additional interest
accrued through the time of payment. Some or all of this amount would be
refunded if the Company were to prevail on appeal.
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